Corporate finance -assignment 4-(question 4 is composed of two


4-(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 A
Asset Turnover
Interest Burden
Financial Leverage
Income Tax Rate
Using only the data in the table 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 State 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
Workign Capital                                               $123                                                $157
Total Debt                                                        $16                                                  $0
Total Shareholders’ Equity                              $159                                                $220


5- David Wright CEA. An analyst with River Investment is considering buying a Montrose Cable Company corporate bond. He has collect 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.

a.       Calculate the combined effect of the three of balance sheet items in the Exhibit 10.12 on each of the following three financial ratios shown in Exhibit 10.11

1-EBITDA/interest expense.

2- Long-term debt/equity.

3-Current assets/current liabilities.

The bond is currently trading at the credit premium of 25 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 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 {Use Thousands}

Balance sheet                                                                                                                                .

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

Shareholder’s equity                                                                                                          33,460

Total liabilities and Shareholder’s equity                                                                        47,960

Income Statement                                                                                                                           .

Revenue                                                                                                                                  $18,500

Operating and administrative expenses                                                                           $14,050

Operating income                                                                                                            $4,450

Depreciation and amortization                                                                                          $1,675

Internet expense                                                                                                                  $942

Income before income taxes                                                                                               $1,833

Taxes                                                                                                                                    $641

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 only0 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 discount 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 

Credit Yield

Interest Coverage                                            Current Ratio                    premium over

{EBITDA/interest              Leverage Long[Current assets/  U.S. Treasuries

Bond Rating        Expense}                         -term debtequityCurrent liabilities]             in basis points

AA                      5.00 to 6.00                     0.25 to 0.30            1.15 to 1.25                    30 bps

A                        4.00 to 5.00                     0.30 to 0.40            1.00 to 1.15                    50 bps

BBB                    3.00 to 4.00                   0.40 to 0.50           0.90 t0 1.00                  100bps

BB                       2.00 to 3.00                  0.50 to 0.60            0.75 to .090                  125bvps


6- . 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?

7- The Shamrock Dogfood Company (SDC) has consistently paid out 40 percent of its earnings in divi- dends. The company’s return on equity is 16 percent. What would you estimate as its dividendgrowth rate?

8-– What P/E ratio would you apply if you learned that SDC had decided to increase its payout to50 percent? (Hint: This change in payout has multiple effects.)

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