RobertA

If a firm has a return on equity of 15%, a current dividend of $1.00, and a sustainable growth rate of 9%, what are the firm’s current earnings?

A) $2.50.

B) $1.50.

C) $1.75.

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The earnings can be determined by solving for earnings in the sustainable growth formula:
9% = [1 − ($1 / $Earnings)] × 0.15 or $1 / 0.4 = $Earnings = $2.50

RobertA

Which of the following is NOT a component of the sustainable growth rate formula using the DuPont model?

A) EBIT/interest expense.

B) Net income/sales.

C) Earnings retention ratio.

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SGR = b × ROE
where:
b = earnings retention rate = (1 − dividend payout rate)
ROE = return on equity
The SGR is important because it tells us how quickly a firm can grow with internally generated funds. A firm’s rate of growth is a function of both its earnings retention and its return on equity. ROE can be estimated with the DuPont formula, which presents the relationship between margin, sales, and leverage as determinants of ROE. In the 3-part version of the DuPont model: ROE = (NI/sales)(sales/assets)(assets/equity)

RobertA

Demonstrate the use of the DuPont analysis of return on equity in conjunction with the sustainable growth rate expression. The following statistics are selected from Kyle Star Partners (Kyle) financial statements:

Sales	$100 million
Net Income	$15 million
Dividends	$5 million
Total Assets	$150 million
Total Equity	$50 million

What is Kyle’s sustainable growth rate?

A) 24.5%.

B) 33.3%.

C) 20.0%.

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SGR	= ROE × [(net income − dividends) / net income]
	= (15 million / 50 million) × (15 million − 5 million) / 15 million
	= 20.0%

RobertA

Supergro has current dividends of $1, current earnings of $3, and a sustainable growth rate of 10%. What is Supergro’s return on equity?

A) 12%.

B) 15%.

C) 20%.

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The ROE for Supergro can be determined by solving for ROE in the sustainable growth formula:

ROE = 10% / [1 – ($1/$3)] = 15%

RobertA

If Cantel, Inc., has current earnings of $17, dividends of $3.50, and a sustainable growth rate of 11%, what is its return on equity (ROE)?

A) 13.85%.

B) 17.64%.

C) 11.91%.

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Cantel’s ROE is 13.85%:

ROE = 11% / [1 – ($3.50/$17.00)] = 13.85%

RobertA

In the five-part DuPont model ROE = (NI/EBT)(EBT/EBIT)(EBIT/sales)(sales/assets)(assets/equity), the product of the first three terms is:

A) net profit margin.

B) gross profit margin.

C) operating profit margin.

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(NI/EBT)(EBT/EBIT)(EBIT/sales) = (NI/sales) = net profit margin.

RobertA

Financial models such as the DDM represent a cornerstone of equity valuation from an academic standpoint. But in the real life, many analysts do not use the DDM. The least likely reason for this is:

A) some of the assumptions required are impractical.

B) the model lacks the flexibility required to model values in the real world.

C) modern research has shown that many of the old standbys do not work.

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The DDM requires assumptions that many analysts find impractical. In addition, the model lacks the flexibility to adapt to changing circumstances. Both of these problems can be overcome, to a large extent, by using spreadsheet modeling to forecast cash flows and other variables.

RobertA

Relative to traditional financial models like the dividend discount model, the biggest advantage of spreadsheet modeling is:

A) accuracy of computations.

B) simplicity of computations.

C) quantity of computations.

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Computations are no simpler or more complicated on a spreadsheet as opposed to a calculator. Accuracy tends to be improved with the use of a spreadsheet, because you don’t have to punch numbers into a calculator at any stage. However, someone truly concerned with accuracy can do a fine job with a calculator. The spreadsheet stands out when it comes to quantity. Analysts can program many permutations and scenarios into a spreadsheet, using minutes to do what would take hours or even days or weeks with a calculator.

RobertA

Which of the following actions will be least helpful for an analyst attempting to improve the predictive power of his scenario analysis?

A) Acquiring more precise inputs.

B) Limiting deviations from the core model.

C) Using a spreadsheet rather than a calculator.

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The whole point of scenario analysis is the flexibility to modify the inputs to see how changes in one factor affect others. In order to perform scenario analysis, you must deviate from the core model. Increased precision on the inputs will increase the predictive power of almost any model. Spreadsheets reduce the likelihood of computational inaccuracies and allow analysts to more easily modify models to reflect many scenarios.

RobertA

The current market price per share for High-on-the-Hog, Inc. is $52.50, and an analyst is using the Gordon Growth model to determine whether this is a fair price. The company paid a dividend of $3.00 last year on earnings of $4.50 a share. If the required rate of return is 11.00% and the expected grown rate in earnings and in dividends is 5%, the current market price is most likely:

A) correctly valued.

B) undervalued.

C) overvalued.

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The value per share using the estimates is $52.50 = [$3.00(1.05) / 0.11 − 0.05)].