(Question 4 is composed of two parts.) The DuPont formula defines the net return on shareholders’ equity as a function of the following components:
· Operating margin
· Asset turnover
· Interest burden
· Financial leverage
· Income tax rate
Using only the data in the table shown below:
a. Calculate each of the five components listed above for 2010 and 2014, and calculate the return on equity (ROE) for 2010 and 2014, using all of the five components. Show calculations.
b. Briefly discuss the impact of the changes in asset turnover and financial leverage on the change in ROE from 2010 to 2014
INCOME STATEMENT DATA 2010 2014
Revenues $542 $979
Operating income 38 76
Depreciation and amortization 3 9
Interest expense 3 0
Pretax income 32 67
Income taxes 13 37
Net income after tax 19 30
BALANCE SHEET DATA 2010 2014
Fixed assets $41 $70
Total assets 245 291
Working capital 123 157
Total debt 16 0
Total shareholders’ equity 159 220
David Wright, CFA, an analyst with Blue River Investments, is considering buying a Montrose Cable Company corporate bond. He has collected the following balance sheet and income statement information for Montrose as shown in Exhibit 10.10. He has also calculated the three ratios shown in Exhibit 10.11, which indicate that the bond is currently rated “A” according to the firm’s internal bond-rating criteria shown in Exhibit 10.13. Wright has decided to consider some off-balance-sheet items in his credit analysis, as shown in Exhibit 10.12. Specifically, Wright wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Exhibit 10.11.
iii.Current assets/current liabilities
The bond is currently trading at a credit premium of 55 basis points. Using the internal bond-rating criteria in Exhibit 10.13, Wright wants to evaluate whether or not the credit yield premium incorporates the effect of the off-balance-sheet items.
b.State and justify whether or not the current credit yield premium compensates Wright for the credit risk of the bond based on the internal bond-rating criteria found in Exhibit 10.13.
EXHIBIT 10.10 MONTROSE CABLE COMPANY YEAR ENDED MARCH 31, 2011
Current assets $4,735
Fixed assets 43,225
Total assets $47,960
Current liabilities $4,500
Long-term debt 10,000
Total liabilities $14,500
Shareholders’ equity 33,460
Total liabilities & shareholders’ equity $47,960
Operating & administrative expenses 14,050
Operating income 4,450
Depreciation & amortization 1,675
Interest expense 942
Income before income taxes $1,833
Net income $1,192
EXHIBIT 10.11 SELECTED RATIOS AND CREDIT YIELD PREMIUM DATA FOR MONTROSE
EBITDA/interest expense 4.72
Long-term debt/equity 0.30
Current assets/current liabilities 1.05
Credit yield premium over U.S. Treasuries 55 basis points
EXHIBIT 10.12 MONTROSE OFF-BALANCE-SHEET ITEMS
· Montrose has guaranteed the long-term debt (principal only) of an unconsolidated affiliate. This obligation has a present value of $995,000.
· Montrose has sold $500,000 of accounts receivable with recourse at a yield of 8 percent.
· Montrose is a lessee in a new noncancelable operating leasing agreement to finance transmission equipment. The discounted present value of the lease payments is $6,144,000 using an interest rate of 10 percent. The annual payment will be $1,000,000.
EXHIBIT 10.13 BLUE RIVER INVESTMENTS: INTERNAL BOND-RATING CRITERIA AND CREDIT YIELD PREMIUM DATA
Interest Coverage (EBITDA/interest expense
Leverage (long-term debt/equity)
Current Ratio (current assets/current liabilities
Credit Yield Premium over US Treasuries (in basis points)
5.00 to 6.00
4.00 to 5.00
3.00 to 4.00
2.00 to 3.00
0.25 to .30
0.30 to 0.40
0.40 to 0.50
0.50 to 0.60
1.15 to 1.25
1.00 to 1.15
0.90 to 1.00
0.75 to 0.90
Over the long run, you expect dividends for BBC in Problem 4 to grow at 8 percent and you require 11 percent on the stock. Using the infinite period DDM, how much would you pay for this stock?
The Shamrock Dogfood Company (SDC) has consistently paid out 40 percent of its earnings in dividends. The company’s return on equity is 16 percent. What would you estimate as its dividend growth rate?
What P/E ratio would you apply if you learned that SDC had decided to increase its payout to 50 percent? (Hint: This change in payout has multiple effects.)
Why Work with Us
Top Quality and Well-Researched Papers
We always make sure that writers follow all your instructions precisely. You can choose your academic level: high school, college/university or professional, and we will assign a writer who has a respective degree.
Professional and Experienced Academic Writers
We have a team of professional writers with experience in academic and business writing. Many are native speakers and able to perform any task for which you need help.
Free Unlimited Revisions
If you think we missed something, send your order for a free revision. You have 10 days to submit the order for review after you have received the final document. You can do this yourself after logging into your personal account or by contacting our support.
Prompt Delivery and 100% Money-Back-Guarantee
All papers are always delivered on time. In case we need more time to master your paper, we may contact you regarding the deadline extension. In case you cannot provide us with more time, a 100% refund is guaranteed.
Original & Confidential
We use several writing tools checks to ensure that all documents you receive are free from plagiarism. Our editors carefully review all quotations in the text. We also promise maximum confidentiality in all of our services.
24/7 Customer Support
Our support agents are available 24 hours a day 7 days a week and committed to providing you with the best customer experience. Get in touch whenever you need any assistance.
Try it now!
How it works?
Follow these simple steps to get your paper done
Place your order
Fill in the order form and provide all details of your assignment.
Proceed with the payment
Choose the payment system that suits you most.
Receive the final file
Once your paper is ready, we will email it to you.
No need to work on your paper at night. Sleep tight, we will cover your back. We offer all kinds of writing services.
No matter what kind of academic paper you need and how urgent you need it, you are welcome to choose your academic level and the type of your paper at an affordable price. We take care of all your paper needs and give a 24/7 customer care support system.
Admission Essays & Business Writing Help
An admission essay is an essay or other written statement by a candidate, often a potential student enrolling in a college, university, or graduate school. You can be rest assurred that through our service we will write the best admission essay for you.
Our academic writers and editors make the necessary changes to your paper so that it is polished. We also format your document by correctly quoting the sources and creating reference lists in the formats APA, Harvard, MLA, Chicago / Turabian.
If you think your paper could be improved, you can request a review. In this case, your paper will be checked by the writer or assigned to an editor. You can use this option as many times as you see fit. This is free because we want you to be completely satisfied with the service offered.