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Reading 41: Financial Analysis Techniques - LOS g ~ Q1-5

1.Are the statements about the following valuation metrics true or false?
Statement #1 – As compared to the price-to-earnings ratio, the price-to-cash flow ratio is easier to manipulate because management can easily control the timing of the cash flows.
Statement #2 – One of the benefits of earnings per share as a valuation metric is that it facilitates the comparison of firms of different sizes.

Statement #1

Statement #2

 

A)              False                                         True

B)              True                                          False

C)              False                                        False

D)              True                                           True

 

2.Would an increase in net profit margin or in the firm’s dividend payout ratio increase a firm’s sustainable growth rate?

Net profit margin

Dividend payout ratio

 

A)             Yes                                             Yes

B)              No                                                No

C)              No                                              Yes

D)              Yes                                              No

 

3.An analysis of the industry reveals that firms have been paying out 45 percent of their earnings in dividends, asset turnover = 1.2; asset-to-equity (A/E) = 1.1 and profit margins are 8 percent. What is the industry’s projected growth rate?

A)   4.55%.

B)   4.95%.

C)   5.81%.

D)   5.25%.

 

4.A firm’s financial statements reflect the following:

Net profit margin

15%

Sales

$10,000,000

Interest payments

$1,200,000

Avg. assets

$15,000,000

Equity

$11,000,000

Avg. working capital

$800,000

Dividend payout rate

35%

Which of the following is the closest estimate of the firm’s sustainable growth rate?

A)   9%.

B)   8%.

C)   10%.

D)   11%.

 

5.A firm’s financial statements reflect the following:

EBIT

$2,000,000

Sales

$16,000,000

Interest expense

$900,000

Total assets

$12,300,000

Equity

$7,000,000

Effective tax rate

35%

Dividend payout rate

28%

Based on this information, what is the firm’s sustainable growth rate?

A)   7.35%.

B)   8.82%.

C)   9.10%.

D)   10.63%.

答案和详解如下:

1.Are the statements about the following valuation metrics true or false?
Statement #1 – As compared to the price-to-earnings ratio, the price-to-cash flow ratio is easier to manipulate because management can easily control the timing of the cash flows.
Statement #2 – One of the benefits of earnings per share as a valuation metric is that it facilitates the comparison of firms of different sizes.

Statement #1

Statement #2

A)                False                                      True

B)                True                                        False

C)                False                                      False

D)                True                                        True

The correct answer was C)

Although manipulation of cash flow can occur, the P/E ratio is easier to manipulate because earnings are based on the numerous estimates and judgments of accrual accounting. EPS does not facilitate comparisons among firms. Two firms may have the same amount of earnings but the number of shares outstanding may differ significantly.

 

2.Would an increase in net profit margin or in the firm’s dividend payout ratio increase a firm’s sustainable growth rate?

Net profit margin

Dividend payout ratio

 

A)                Yes                                          Yes

B)                No                                            No

C)                No                                            Yes

D)                Yes                                          No

The correct answer was D)

The sustainable growth rate is equal to ROE multiplied by the retention rate. According to the Dupont formula, an increase in net profit margin will result in higher ROE. Thus, an increase in net profit margin will result in a higher growth rate. The retention rate is equal to 1 minus the dividend payout ratio. Thus, an increase in the dividend payout ratio will lower the retention rate and lower the growth rate.

 

3.An analysis of the industry reveals that firms have been paying out 45 percent of their earnings in dividends, asset turnover = 1.2; asset-to-equity (A/E) = 1.1 and profit margins are 8 percent. What is the industry’s projected growth rate?

A)   4.55%.

B)   4.95%.

C)   5.81%.

D)   5.25%.

The correct answer was C)

ROE = profit margin × asset turnover × A/E = 0.08 × 1.2 × 1.1 = 0.1056
RR = (1 - 0.45) = 0.55
g = ROE × RR = 0.1056 × 0.55 = 0.0581

 

4.A firm’s financial statements reflect the following:

Net profit margin

15%

Sales

$10,000,000

Interest payments

$1,200,000

Avg. assets

$15,000,000

Equity

$11,000,000

Avg. working capital

$800,000

Dividend payout rate

35%

Which of the following is the closest estimate of the firm’s sustainable growth rate?

A)   9%.

B)   8%.

C)   10%.

D)   11%.

The correct answer was A)

Return on equity (ROE) = net profit margin × asset turnover × leverage = (0.15)(0.67)(1.364) = 0.137.
The sustainable growth = (1 – dividend rate)(ROE) = (0.65)(0.137) = 8.9%.

 

5.A firm’s financial statements reflect the following:

EBIT

$2,000,000

Sales

$16,000,000

Interest expense

$900,000

Total assets

$12,300,000

Equity

$7,000,000

Effective tax rate

35%

Dividend payout rate

28%

Based on this information, what is the firm’s sustainable growth rate?

A)   7.35%.

B)   8.82%.

C)   9.10%.

D)   10.63%.

The correct answer was A)

With this information, ROE = [(0.1250)(1.3008) – 0.0732](1.7571)(0.65) = 0.1021.
Sustainable growth = ROE (1 – dividend payout rate) = 0.1021 × 0.72 = 7.35%.

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