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(A)
Adequate information:
| Components | Quick brush company(in $) | Smile white corporation (in $) |
| Net Profit | 445 | 4850 |
| Pretax Profit | 660 | 7350 |
| EBIT | 660 | 7700 |
| Sales | 7760 | 119200 |
| Assets | 5470 | 33600 |
| Equity | 3720 | 22700 |
| Dividend per share | 0 | 1.72 |
| Earnings Per Share(EPS) | 1.18 | 2.62 |
Requirement 1: To calculate and analyze five components that determine
Introduction:
Return on Equity measures the financial performance of the company by focusing only on the profitability of equity investments. It is expressed as:
Though in Du-pont system, the return on equity is decomposed into five components. Thus decomposed return on equity is calculated as:
= Tax burden X Interest burden X Margin X Turnover X Leverage
Explanation of Solution
Calculation of Return on Equity using five components for Quick Brush company and smile white corporation.
Though the Margin for profits in Quick Brush Company (8.5%) is more than Smile White Corporation(6.4%), but the Return on equity is less in Quick brush company(11.87%) as compared to Smile white corporation(21.12%). Thus Quick Brush company is not profitable from shareholders point. Also the Turnover of assets in Quick brush is also less (1.41) as compared to Smile White Corporation which shows that Quick brush company earns less from its total assets as compared to Smile white corporation.
Requirement 2: To calculate and analyze ROE and plowback ratios that determine sustainable growth.
Introduction:
The sustainable growth is the maximum growth rate that a firm can sustain without having to lookout for outside finance. It is multiple of return on equity and retention ratio. It is calculated as:
Sustainable Growth
Explanation of Solution
Calculation of Sustainable growth
Since the sustainable growth rate shows the firm's dependency on dividend policy and profitability, thus here the analyst- Janet Ludlow is confident on both the firm's sustainable growth rate.
(B)
To explain that the Quick Brush Company is having average annual Earning per share growth rate of 40% in last two years though the Return on Equity is declining in two years.
Introduction:
Earning per share is the portion of a firm's profit allocated to each share of common stock. A firm with high Earning per share ratio means that it is capable of generating high dividends for investors of common stock or it may plow back funds for business growth.
Return on Equity measures the financial performance of the company by focussing only on the profitability of equity investments. It is expressed as:
Answer to Problem 4CP
Quick Brush Company has growing Earning Per Share but declining ROE because it has increased its book value per share over the period of two years.
Explanation of Solution
Quick Brush Company has a declining Return On Equity because it had
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