Lesson 2 Homework
1. Why is the DuPont identity a valuable tool for analyzing the performance of a firm? Discuss
the types of information it reveals compared to ROE considered by itself.
Answer:
2. Why do you think most long-term financial planning begins with sales forecasts? Put
differently, why are future sales the key input?
Answer:
Example Question: Calculating Market Value Ratios: Makers Corp. had additions to retained earnings
for the year just ended of $415,000. The firm paid out $220,000 in cash dividends, and it has ending
total equity of $5.6 million. If the company currently has 170,000 shares of common stock
outstanding, what are earnings per share? Dividends per share? Book value per share? If the stock
currently sells for $65 per share, what is the market-to-book ratio? The price-earnings ratio? If the
company had sales of $7.45 million, what is the price-sales ratio?
Answer: (Please see Excel Sheet as well for better understanding on calculation)
Net income = Addition to RE + Dividends = $415,000 + 220,000 = $635,000
Earnings per share = NI/Shares = $635,000/170,000 = $3.74 per share
Dividends per share = Dividends/Shares = $220,000/170,000 = $1.29 per share
Book value per share = TE/Shares = $5,600,000/170,000 = $32.94 per share
Market-to-book ratio = Share price/BVPS = $65/$32.94 = 1.97 times
PE ratio = Share price/EPS = $65/$3.74 = 17.40 times
Sales per share = Sales/Shares = $7,450,000/170,000 = $43.82
P/S ratio = Share price/Sales per share = $65/$43.82 = 1.48 times
Question 3: Calculating Market Value Ratios: MM Corp. had additions to retained earnings for the
year just ended of $615,000. The firm paid out $280,000 in cash dividends, and it has ending total
equity of $5.6 million. If the company currently has 180,000 shares of common stock outstanding,
what are earnings per share? Dividends per share? Book value per share? If the stock currently sells
for $75 per share, what is the market-to-book ratio? The price-earnings ratio? If the company had
sales of $9.50 million, what is the price-sales ratio?
Please answer based on above example. You may like to use the excel sheet to get the answer.
Example Question: Enterprise Value-EBITDA Multiple: The market value of the equity of Hudgins, Inc.,
is $645,000. The balance sheet shows $53,000 in cash and $215,000 in debt, while the income
statement has EBIT of $91,000 and a total of $157,000 in depreciation and amortization. What is the
enterprise value-EBITDA multiple for this company?
Answer: (Please see Excel Sheet as well for better understanding on calculation)
First, we need the enterprise value, which is:
Enterprise value = Market capitalization + Debt – Cash
Enterprise value = $645,000 + 215,000 – 53,000
Enterprise value = $807,000
And EBITDA is:
EBITDA = EBIT + Depreciation & Amortization
EBITDA = $91,000 + 157,000
EBITDA = $248,000
So, the enterprise value-EBITDA multiple is:
Enterprise value-EBITDA multiple = $807,000/$248,000
Enterprise value-EBITDA multiple = 3.25 times
Question 4: Enterprise Value-EBITDA Multiple: The market value of the equity of ABC, Inc., is
$750,000. The balance sheet shows $55,000 in cash and $215,000 in debt, while the income statement
has EBIT of $95,000 and a total of $165,000 in depreciation and amortization. What is the enterprise
value-EBITDA multiple for this company?
Please answer based on above example. You may like to use the excel sheet to get the answer.
Example Question: Sustainable Growth: Assuming the following ratios are constant, what is the
sustainable growth rate?
Total asset turnover = 2.90
Profit margin = 5.2%
Equity multiplier = 1.10
Payout ratio = 35%
Answer: (Please see Excel Sheet as well for better understanding on calculation)
We must first calculate the ROE using the DuPont ratio to calculate the sustainable growth rate. The ROE
is:
ROE = (PM)(TAT)(EM)
ROE = (.052)(2.9)(1.10)
ROE = .1659, or 16.59%
The plowback ratio is one minus the dividend payout ratio, so:
b = 1 – .35
b = .65
Now we can use the sustainable growth rate equation to get:
Sustainable growth rate = (ROE × b)/[1 – (ROE × b)]
Sustainable growth rate = [.1659(.65)]/[1 – .1659(.65)]
Sustainable growth rate = .1209, or 12.09%
Question 5: Sustainable Growth: Assuming the following ratios are constant, what is the sustainable
growth rate?
Total asset turnover = 2.40
Profit margin = 7.5%
Equity multiplier = 1.15
Payout ratio = 30%
Please answer based on above example. You may like to use the excel sheet to get the answer.