1.

The DuPont formula defines the net return on shareholders equity as a function of the following
components:

Operating margin

Asset turnover

Interest burden

Financial leverage

Income tax rate

Refer to the information presented on the financial position of Oberyn Martell Incorporated in
Table 1A below to answer the following questions.

(a).

Calculate each of the five components listed for 2009 and 2013, and calculate the return on
equity (ROE) for 2009 and 2013, using all of the five components. Show all calculations.

For 2009:
1. Operating Margin= Net Income/Sales
= 19/542
=0.03
Net Income= Pretax Income Income Tax = Net Income
= 32-13=19
2. Asset Turnover= Sales/ Total Assets
= 542/245
= 2.21
3. Interest Burden= Interest expense/ Total Assets
=3/245
=0.01
4. Financial leverage= Total Assets/ Common Equity
= 245/159
=1.54
5. Income tax rate= (100%-Income taxes/ Net before Tax)
= (100%- 13/19)
= 0.6%

Return on Equity (ROE) = Operating Margin x Total Asset Turnover x Financial Leverage
= 0.03 x 2.21 x 1.54=
= 0.10=10%
For 2013:
1. Operating Margin=Net Income/Sales
= 67/979
=0.07

2. Asset Turnover= Sales/ Total Assets

= 979/291
= 3.36
3. Interest Burden= Interest expense/ Total Assets
=0/245
=0
4. Financial leverage= Total Assets/ Common Equity
= 291/220
=1.32
5. Income tax rate= (100%-Income taxes/ Net before Tax)
= (100%- 37/67)
= 0.45%

Return on Equity (ROE) = Operating Margin x Total Asset Turnover x Financial Leverage
= 0.07 x 3.36 x 1.32
= 0.31=31%

(b).

Briefly discuss the impact of the changes in asset turnover and financial leverage on the
change in ROE from 2009 and 2013.

2009

2013

Asset turnover

2.21

3.36

Financial leverage

1.54

1.32

If the asset turnover increases, the firm generates more sales for every unit of assets
owned, resulting in a higher overall ROE. Also, increasing financial leverage means that the
firm uses more debt financing relative to equity financing. Financial leverage benefits
diminish as the risk of defaulting on interest payments increases. So if the firm takes on too
much debt, the cost of debt rises as creditors demand a higher risk premium, and ROE
decreases.

Q2.

Petyr Baelish is reviewing Valyrias financial statements in order to estimate its sustainable
growth rate. Refer to the information presented in Table 2A below to answer this question.

(a).

(1)

Identify and calculate the three components of the DuPont formula.

For 2009:

Operating Margin = Net income/ Sales

= 510/5140
= 0.09
Asset Turnover = Sales/ Total Assets
= 5140/3100
= 1.66
Financial leverage = Total Assets/ Common Equity
=3100/2200
= 1.40

(2)

Calculate the ROE for 2009 using the three components of the DuPont formula.

Return on Equity (ROE) 2009 = = Operating Margin x Asset Turnover x Financial Leverage=
= 0.09 x 1.66 x 1.4=
=0.21=21%

(3)

Calculate the sustainable-growth rate for 1999.

Sustainable Growth Rate= ROE x RR (percentage of earnings retained)

RR(retention rate of earnings)= Dividends per Share (DPS) / Earnings per Share (EPS)

RR 2009=0.60/1.96=0.31
2009: SGR = 0.21x (1- 0.31)
= 0.145=14.5%
(b).
Cite two courses of action (other than ignoring the problem) Petyr Baelish should encourage
Valyria to take, assuming the calculated sustainable-growth rate continues to exceed the actual
growth rate
If sustainable growth rate is greater than actual growth, the company might be underperforming.

There are 2 courses of actions we can do:

1. Return the money to shareholders.

The most direct solution of this problem of idle resources is to simply return the money to
owners by increasing dividends or repurchasing shares. Although this may not be the choice of
strategy among many executives.
This is because by doing so may trigger an impression towards that the company is not doing
well.
2. Buy growth
The next way to eliminate slow growth problems is to buy growth. This means by companies
venturing into other more vibrant industries. Since time would be the main factor, usually an
organization opts to acquire an existing businesses rather than starting new ones from scratch.

Q3
At year-end 2011, the Wall Street consensus was that Philip Morris earnings and dividends would
grow at 20 percent for five years after which growth would fall to a market-like 7 percent.
Analysts also projected a required rate of return of 10 percent for the U.S. equity market.

(a).

Using the data in Table 3A and the multistage dividend discount model, calculate the intrinsic
value of Philip Morris stock at year-end 2011. Assume a similar level of risk for Philip Morris
stock as for the typical U.S. stock. Show all work.

g- growth rate= 20%

k-required rate=10%

D0 Dividends per share=1.91

D1=D0 x (1+g) =
= 1.91x (1+0.2) = 2.292
D2 = 2.292 x (1+0.2) = 2.75
D3 =2.75 x (1+0.2) = 3.30
D4 = 3.30 x(1+0.2)=3.96
D5 =3.96 x (1+0.2) =4.75
Intrinsic Value = (D1/ 1+k)+ (D2/ (1+k)2)+ (D3/ (1+k)3) +(D4/ (1+k)4) +( D5/(1+k)5)=
= (2.29/1+0.1) + (2.75/ (1+ 0.1)2) + (3.30/ (1+0.1)3) + (3.96/(1+0.1)4)+4.75/(1+0.1)5)=
= 2.08 +2.28+2.48+2.7+2.95=12.49

(b).

Using the data in Table 3A, calculate Philip Morris price/earnings ratio and the
price/earnings ratio relative to the S&P Industrials Index as of December 31, 2011.

Price/earnings ratio= Market value per Share/ Earnings per Share

=Closing price common stock/Earnings per Share=
=80.250/4.24=
=18.92

Price/earnings ratio the S&P Industrials Index= 417.09/16.29=25.6

(c).

Using the data in Table 3A, calculate Philip Morris price/book ratio and the price/book ratio
relative to the S&P Industrials Index as of December 31, 2011.

Price/book ratio= Market Value per Share/Book value per Share=

=Closing price common stock/ Book value per Share=
= 80.250/161.08=0.498
Price/book ratio relative to the S&P Industrials Index= 417.09/161.08=2.59

(d). State one major advantage and one major disadvantage of each of the three valuation
methodologies you used to value Philip Morris stock in Questions a, b and c above.

Price/earnings ratio

Advantage

Disadvantage

Most commonly used

EPS can be subject to

equity multiple

differences in accounting

Data availability is high

policies and
manipulation

Unless adjusted, can be

subject to one-off
exceptional items

Cannot be used if
earnings are negative

Price/book ratio

Can be useful where

Book values for tangible

assets are a core driver

assets are stated at

of earnings such as

historical cost, which is

capital-intensive

not a reliable indicator of

industries

economic value

Most widely used in

Book value for tangible

valuing financial

assets can be

companies, such as

significantly impacted by

banks, which rely on a

differences in accounting

large asset base to

policies

generate profits

(e). State whether Philip Morris stock is undervalued or overvalued as of December 31,
2011.Support your conclusion using your answers to previous questions and any data provided.
(The past 10-year average S&P Industrials Index relative price/earnings and price/book ratios for
Philip Morris were 0.80 and 1.61, respectively.)
As the price-to-earnings ratio is one of the main metrics investors use to decide if a stock is
properly valued. Once you know the P/E ratio for a stock, you should compare that to the
P/Es of other companies in that industry and get a sense of what the average P/E is for the
group. As given an example in our case, Philip Morris stock with calculated price/earnings
ratio 18.92 towards to Price/earnings ratio the S&P Industrials Index which is 25.6 its
possible to make conclusion that the stock is undervalued.