Specific ratios related to financial analysis

Index
1.
2.
3.
4.
5.
6.
7.

Financial Leverage or Capital Gearing

Dividend Payout Ratio
Price Earnings P/E Ratio
Dividend Yield Ratio
EBITDA Margin
Retention Rate
Cash Coverage Ratio

Ratio # 1 Financial Leverage or Capital Gearing

Preference shares carry a fixed rate of dividend and debentures carry a fixed rate of interest.
The equity shares are paid dividend out of profits left after payment of interest on debentures,
and dividend on preference shares.
Thus, dividend on equity shares may vary year after year. Equity shares are known as variable
return securities and debentures and preference shares as fixed return securities. If the rate of
return on fixed return securities is lower than the rate of earnings of the company, the return on
equity shares will be higher.
This phenomenon is known as financial leverage or capital gearing. Thus, financial leverage is
an arrangement under which fixed return bearing securities (debentures and preference shares)
are used to raise cheaper funds to increase the return to equity shareholders. It may be noted
that a lever is used to lift something heavy by applying less force than required otherwise.
Capital gearing denotes the ratio between various types of securities and Under-Capitalization
total capitalisation. Capitalisation of a company is highly geared when the proportion of equity to
total capitalisation is small and it is low geared when the equity capital dominates the capital
structure.

Capital gearing ratio represents the relationship between equity share capital of a firm and its
fixed interest bearing funds. Fixed interest bearing funds include preference share capital,
debentures, bonds and other type of loans which bear a fixed rate of interest on it.
This ratio is used to measure the degree of leverage of a firm. A firm having low capital gearing
ratio will be called as highly leveraged and vice versa.

Equity share capital

Fixed interest bearing funds

Specific ratios related to financial analysis

Where:
Equity share capital refers to total share capital plus reserves minus preference share capital.

Capital gearing is calculated by determining the ratio between the amount of equity capital
(representing variable income bearing securities) and the total amount of securities (equity
shares, preference shares and debentures) issued by a company.
Q1:
Each of the two companies have issued the total securities worth Rs. 20,00,000 and they have
equity shares worth Rs. 5,00,000 and Rs. 15,00,000 respectively. Company A is highly geared
as the ratio between equity capital to total capitalization is small, i.e., 25%. But in case of
Company B, this ratio is 75%, so it is low geared.

The various securities issued should bear such ratio to total capitalisation that capital structure
is safe and economical. Equity shares should be issued where there is uncertainty of earnings.
Preference shares, particularly the cumulative ones, should be issued when the average
earnings are expected to be fairly good. Debentures should be issued when the company
expects fairly higher earnings in future to pay interest to the debenture holders and increase the
return of equity shareholders.

Q 2:

Lets assume that ABC Ltd Company has following figures on its balance sheet:
2012

Specific ratios related to financial analysis

Equity share capital

1,00,00,000

Preference share capital

28,00,000

Debentures

25,00,000

Bonds

27,00,000

Using the above given figures, we are able to calculate capital gearing ratio for year
2012 and 2013 separately.

Solution: For the year 2012:

1, 00, 00,000 / 80, 00,000 = 1.25: 1
For the year 2013:
92.0, 00,000/ 1, 12, 50,000 = 0.8: 1

The above results show that the company was low geared (leveraged) in 2012 whereas it was
highly geared (leveraged) in the year 2013.

Q 3.
From the following information find out capital gearing ratio.
Source

2005

2006

Amount (Rs) Amount (Rs)

Equity share capital
400,000
Reserves & surplus
200,000
8% preference share capital
300,000
6% Debentures
250,000
400,000

500,000
300,000
250,000

Specific ratios related to financial analysis

Ratio # 2 Dividend Payout Ratio
The dividend payout ratio measures the percentage of net income that is distributed to
shareholders in the form of dividends during the year. In other words, this ratio shows the
portion of profits the company decides to keep to fund operations and the portion of profits that
is given to its shareholders.
Investors are particularly interested in the dividend payout ratio because they want to know if
companies are paying out a reasonable portion of net income to investors. For instance, most
startup companies and tech companies rarely give dividends at all. In fact, Apple, a company
formed in the 1970s, just gave its first dividend to shareholders in 2012.
Conversely, some companies want to spur investors' interest so much that they are willing to
pay out unreasonably high dividend percentages. Inventors can see that these dividend rates
can't be sustained very long because the company will eventually need money for its
operations.
Formula

The dividend payout formula is calculated by dividing total dividend by the net income of the
company.

This calculation will give you the overall dividend ratio. Both the total dividends and the net
income of the company will be reported on the financial statements.
You can also calculate the dividend payout ratio on a share basis by dividing the dividends per
share by the earnings per share.
Obviously, this calculation requires a little more work because you must figure out the earnings
per share as well as divide the dividends by each outstanding share. Both of these formulas will
arrive at the same answer however.

Specific ratios related to financial analysis

Analysis
Since investors want to see a steady stream of sustainable dividends from a company, the
dividend payout ratio analysis is important. A consistent trend in this ratio is usually more
important than a high or low ratio.
Since it is for companies to declare dividends and increase their ratio for one year, a single
high ratio does not mean that much. Investors are mainly concerned with sustainable
trends. For instance, investors can assume that a company that has a payout ratio of 20
percent for the last ten years will continue giving 20 percent of its profit to the shareholders.
Conversely, a company that has a downward trend of payouts is alarming to investors. For
example, if a company's ratio has fallen a percentage each year for the last five years might
indicate that the company can no longer afford to pay such high dividends. This could be an
indication of poor operating performance.
Generally, more mature and stable companies tend to have a higher ratio than newer start
up companies.

Q3.
Joe's Kitchen is a restaurant change that has several shareholders. Joe reported
$10,000 of net income on his income statement for the year. Joe's issued $3,000 of
dividends to its shareholders during the year. Find out Joe's dividend payout ratio
calculation.

Solution:

As you can see, Joe is paying out 30 percent of his net income to his shareholders.
Depending on Joe's debt levels and operating expenses, this could be a sustainable rate
since the earnings appear to support a 30 percent ratio.

Practical Uses for the Dividend Payout and Retention Ratios

The Dividend Payout Ratio is a calculation used to measure the percentage of a companys

Specific ratios related to financial analysis

net income that is paid to shareholders as dividends; whereas the Retention Ratio is a
measure that determines the portion of earnings that are reinvested back into the business.

Q 4.
Company XYZ had quarterly dividend payments last year of 70 cents per share, which
equals a total annual dividend per share of $2.80. XYZ also reported earnings per share
of $5.60. How would you calculate the Dividend Payout Ratio?

Dividend Payout Ratio (DPR) = Annual Dividend per share/Earnings per share
DPR = 2.80/5.60
DPR = 0.50 or 50%
The Retention Ratio is the exact opposite of the dividend payout ratio, and it is calculated by
taking 1 minus the DPR. So, the Retention Ratio for McDonalds would be 50% = 1-50%.
What Does It All Mean?
For investors seeking income, the dividend payout ratio and dividend yield (current
dividend/current price) are useful tools to gauge the annual income generated from the
investment and to compare a company versus its industry peers or another income stock
that you may be considering. If the dividend payout ratio is 53.5%, then investors can expect
the company to pay out 53.5 cents on every dollar earned by the company and reinvest the
remaining 46.5 cents. Low payouts would indicate that the company might be in growth
mode or fairly new; whereas high payouts can indicate maturity.
Companies like AT&T have dividend payout ratios that well exceed 100%. A DPR exceeding
100% indicates that a company is paying out more than it is earning. High payouts can be
problematic and harmful to companies looking to expand or build positive cash flow. In
2013, Century Link (NYSE:CTL) reduced its quarterly dividend from 72 cents in 2012 down
to 54 cents in 2013 to sustain its business model. Dividend reductions are generally not a
positive indicator for the financial condition of a company; thus it can lead to a decrease in
the stock price and investor panic. Century Links stock price decreased by over 20% in the
middle of February 2013, when the company announced it would cut its upcoming dividend.
Increases and Decreases in the Ratio
we stated earlier that a reduced dividend can raise a red flag; however, a lower dividend
payout ratio when compared with the previous year does not necessarily indicate bad news.
Several factors both positive and negative can increase or decrease the dividend payout
ratio:

Specific ratios related to financial analysis

Decreases to the Dividend Payout Ratio (DPR):
- Flat dividend and an increase in earnings
- Decreased dividend and earnings remain unchanged
Increases to the Dividend Payout Ratio (DPR):
- Flat dividend and a decrease in earnings
- Increased dividend and earnings remain unchanged
Conclusion
The risk of investing in stocks can be reduced by implementing a portfolio that contains both
stocks with high dividend payout ratios (dividend stocks) and companies with high retention
ratios (growth stocks). By adding diverse industries and international investments, investors
can further protect themselves and their portfolios to an even greater extent. Be cautious of
companies with extremely high dividend payout ratios, because it can lead to future cash
flow problems or excessive debt. In addition, companies with too much retained earnings
can soar to record high stock prices, accumulate too much cash and also cause investor
concern.

Q 5. Lets say that Jim's Light Bulbs, a new company, earned $200,000 in its first year
of business, but it had to spend $50,000 on the expenses mentioned above. Being a
relatively young company, decided to re-invest most of its net income by expanding its
production capacity and only paid out $3,750 per quarter in dividends.

Solution.
In this case, the net income for Jim's Light Bulbs would be 200,000 - 50,000 = $150,000
Well use 4 times 3,750 =$15,000 as our amount of dividends paid in the first year of
business
Find the dividend payout ratio by dividing 15,000 by 150,000, which is 0.10 (or 10%).

Ratio # 3 Price Earnings P/E Ratio

The price earnings ratio, often called the P/E ratio or price to earnings ratio, is a market
prospect ratio that calculates the market value of a stock relative to its earnings by

Specific ratios related to financial analysis

comparing the market price per share by the earnings per share. In other words, the
price earnings ratio shows what the market is willing to pay for a stock based on its
current earnings.
Investors often use this ratio to evaluate what a stock's fair market value should be by
predicting future earnings per share. Companies with higher future earnings are usually
expected to issue higher dividends or have appreciating stock in the future.
Obviously, fair market value of a stock is based on more than just predicted future
earnings. Investor speculation and demand also help increase a share's price over time.
The PE ratio helps investors analyze how much they should pay for a stock based on its
current earnings. This is why the price to earnings ratio is often called a price multiple or
earnings multiple. Investors use this ratio to decide what multiple of earnings a share is
worth. In other words, how many times earnings they are willing to pay.
Formula
The price earnings ratio formula is calculated by dividing the market value price per
share by the earnings per share.

This ratio can be calculated at the end of each quarter when quarterly financial
statements are issued. It is most often calculated at the end of each year with the
annual financial statements. In either case, the fair market value equals the trading
value of the stock at the end of the current period.
The earnings per share ratio is also calculated at the end of the period for each share
outstanding. A trailing PE ratio occurs when the earnings per share is based on previous
period. A leading PE ratios occurs when the EPS calculation is based on future
predicted numbers. A justified PE ratio is calculated by using the dividend discount
analysis.

Specific ratios related to financial analysis

Analysis
The price to earnings ratio indicates the expected price of a share based on its
earnings. As a company's earnings per share being to rise, so does their market value
per share. A company with a high P/E ratio usually indicated positive future performance
and investors are willing to pay more for this company's shares.
A company with a lower ratio, on the other hand, is usually an indication of poor current
and future performance. This could prove to be a poor investment.
In general a higher ratio means that investors anticipate higher performance and growth
in the future. It also means that companies with losses have poor PE ratios.
An important thing to remember is that this ratio is only useful in comparing like
companies in the same industry. Since this ratio is based on the earnings per share
calculation, management can easily manipulate it with specific accounting techniques.
Q 6.
The Island Corporation stock is currently trading at $50 a share and its earnings per
share for the year is 5 dollars. Island's P/E ratio would be calculated like this:
Solution:

As you can see, the Island's ratio is 10 times. This means that investors are willing to
pay 10 dollars for every dollar of earnings. In other words, this stock is trading at a
multiple of ten.
Since the current EPS was used in this calculation, this ratio would be considered a
trailing price earnings ratio. If a future predicted EPS was used, it would be considered
a leading price to earnings ratio

Specific ratios related to financial analysis

Q 7. MacKline Bank recently reported net profits after tax of $1,000 million. It has 2.5
million shares outstanding and pays dividends on preference shares equal to $1 million
per year.
a. Calculate the firms earnings per share (EPS).
b. Assuming that the share currently trades at $75.80 per share, determine what the
firms dividend yield would be if it paid $10 per share to ordinary shareholders.
c. What would the firms dividend payout ratio be if it paid $10 a share in dividends

Solution:
a. Earnings per share (EPS) =

Net profits after taxes - Preference dividends

Number of ordinary shares outstanding For Mackline Bank:

EPS = $1,000,000,000 - $1,000,000 = $399.6

2,500,000
b. Dividend yield =

Cash dividends per share

Market price per share

For MacKline Bank: Dividend yield = $10 / $75.80 = 13.19%

c. Dividend payout ratio =

Dividends per share

EPS
For MacKLine Bank: Dividend payout ratio = $10 / $399.6 = 2.5%

Ratio # 4 Dividend Yield Ratio

The dividend yield is a financial ratio that measures the amount of cash dividends distributed to
common shareholders relative to the market value per share. The dividend yield is used by
investors to show how their investment in stock is generating either cash flows in the form of
dividends or increases in asset value by stock appreciation.
Investors invest their money in stocks to earn a return either by dividends or stock appreciation.
Some companies choose to pay dividends on a regular basis to spur investors' interest. These
shares are often called income stocks. Other companies choose not to issue dividends and
instead reinvest this money in the business. These shares are often called growth stocks.
Investors can use the dividend yield formula to help analyze their return on investment in stocks.

Specific ratios related to financial analysis

Formula
The dividend yield formula is calculated by dividing the cash dividends per share by the market
value per share.

Cash dividends per share are often reported on the financial statements, but they are also
reported as gross dividends distributed. In this case, you'll have to divide the gross dividends
distributed by the average outstanding common stock during that year.
The shares' market value is usually calculated by looking at the open stock exchange price as
of the last day of the year or period.
Analysis
Investors use the dividend yield formula to compute the cash flow they are getting from their
investment in stocks. In other words, investors want to know how much dividends they are
getting for every dollar that the stock is worth.
A company with a high dividend yield pays its investors a large dividend compared to the fair
market value of the stock. This means the investors are getting highly compensated for their
investments compared with lower dividend yielding stocks.
A high or low dividend yield is relative to the industry of the company. As I mentioned above,
tech companies rarely give dividends at all. So even a small dividend might produce a high
dividend yield ratio for the tech industry. Generally, investors want to see a yield as high as
possible.

Q 8.
Stacy's Bakery is an upscale bakery that sells cupcakes and baked goods in Beverly
Hills. Stacy's is listed on a smaller stock exchange and the current market price per
share is $15. As of last year, Stacy paid $15,000 in dividends with 1,000 shares
outstanding. Stacy's yield is computed like this.

Specific ratios related to financial analysis

As you can see, Stacy's yield is one dollar. This means that Stacy's investors receive 1 dollar in
dividends for every dollar they have invested in the company. In other words, the investors are
getting a 100 percent return on their investment every year Stacy maintains this dividend level.

Ratio # 5 EBITDA
EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization, is a
financial calculation that measures a companys profitability before deductions that are often
considered irrelevant in the decision making process. In other words, its the net income of a
company with certain expenses like amortization, depreciation, taxes, and interest added back
into the total. Investors and creditors often use EBITDA to compare big companies that either
have significant amounts of debt or large investments in fixed assets because this measurement
excludes the accounting effects of non-operating expenses like interest and paper expenses like
depreciation. Adding these expenses back into net income allows us to analyze and compare
the true operating cash flows of the businesses.
Formula
The EBITDA formula is calculated by subtracting all expenses except interest, taxes,
depreciation, and amortization from total revenues.

Often the equation is calculated inversely by starting with net income and adding back the ITDA.
Many companies use this measurement to calculate different aspects of their business. For
instance, since it is a non-GAAP calculation, you can pick and choose what expenses are

Specific ratios related to financial analysis

added back into net income. For example, its not uncommon for an investor to want to see how
debt affects a companys financial position without the distraction of the depreciation expenses.
Thus, the formula can be altered to exclude only taxes and depreciation.
Analysis
EBITDA is a profitability calculation that measures how profitable a company is before paying
interest to creditors, taxes to the government, and taking paper expenses like depreciation and
amortization. This is not a financial ratio. Instead, its a calculation of profitability that is
measured in dollars rather than percentages.
Like all profitability measurements, higher numbers are always preferred over lower numbers
because higher numbers indicate the company is more profitable. Thus, an earnings before
ITDA of $10,000 is better than one of $5,000. This means the first company still has $10,000 left
over after all of its operating expenses have been paid to cover the interest and taxes for the
year. In this sense, its more of a coverage or liquidity measurement than a profitability
calculation.
Since the earnings before ITDA only computes profits in raw dollar amounts, it is often difficult
for investors and creditors to use this metric to compare different sized companies across an
industry. A ratio is more effective for this type of comparison than a straight calculation.

EBITDA Margin
The EBITDA margin takes the basic profitability formula and turns it into a financial ratio that can
be used to compare all different sized companies across and industry. The EBITDA margin
formula divides the basic earnings before interest, taxes, depreciation, and amortization
equation by the total revenues of the company-- thus, calculating the earnings left over after all
operating expenses (excluding interest, taxes, dep, and amort) are paid as a percentage of total
revenue. Using this formula a large company like Apple could be compared to a new start up in
Silicon Valley.

Specific ratios related to financial analysis

The basic earnings formula can also be used to compute the enterprise multiple of a company.
The EBITDA multiple ratio is calculated by dividing the enterprise value by the earnings before
ITDA to measure how low or high a company is valued compared with it metrics. For instance a
high ratio would indicate a company might be currently overvalued based on its earnings.

Q9
Lets look at an example and calculate both the EBITDA and margin for Jakes Ski
House. Jake manufactures custom skis for both pro and amateur skiers. At the end of
the year, Jake earned $100,000 in total revenues and had the following expenses.

Salaries: $25,000
Rent: $10,000
Utilities: $4,000
Cost of Goods Sold: $35,000
Interest: $5,000
Depreciation: $15,000
Taxes: $3,000
Jakes net income at the end of the year equals $3,000. Calculate Jakes EBITDA

Solution:

As you can see, the taxes, depreciation and interest are added back into the net income for
the year showing the amount of earnings Jake was able to generate to cover his interest
and tax payments at the end of the year.
If investor or creditors wanted to compare Jakes Ski shop with another business in the
same industry, they could calculate his margin like this:

Specific ratios related to financial analysis

The EBITDA margin ratio shows that every dollar Jake generates in revenues results in 26
cents of profits before all taxes and interest is paid. This percentage can be used to
compare Jakes efficiency and profitability to other companies regardless of size.

Q 10. Calculate EBITDA & EBITDA Margin

Solution:
Find the line items for EBIT ($750,000), depreciation ($50,000) and amortization (n/a) and then use the formula
above:
EBITDA = 750,000 + 50,000 + 0 = $800,000
Using this information and the formula above, we can calculate Company XYZ's EBITDA margin as:
EBITDA Margin = $800,000/$1,000,000 = 80%
Because EBITDA is a measure of how much cash came in the door, an EBITDA margin is a measure of how
much cash profit a company made in a year.

Specific ratios related to financial analysis

Q 11
Calculations above use line items and figures from the example income statement
shown here.

Calculate EBITDA and EBITDA Margin

Specific ratios related to financial analysis

Formula:
EBIT = R - E
EBIT Margin = EBIT / R
Taxable Income = EBIT - I
Tax Amount = Taxable Income x T
Net Income = Taxable Income - Tax Amount
Profit Margin = Net Income / R

Where

R = Sales Revenue E = Operating Expenses I = Interest Paid T = Tax Rate

Q12:
A company has sales of $500000 with operating costs of $450000, interest paid of
$6000 and a tax rate of 30%. Calculate the EBIT, Net Income, and Profit Margin.
Given:
Sales Revenue (R) = $500000
Operating Expenses (E) = $450000
Interest Paid (I) = $6000
Tax Rate (T) = 30% = 0.3
To Find:
Earnings before Interest and Taxes, Net Income and Profit Margin

Solution:
EBIT = R - E = $500000 - $450000) = $50000 EBIT Margin = EBIT / R = ($50000 / $500000) x 100 =
10 % Taxable Income = EBIT - I = $50000 - $6000 = $44000 Tax Amount = Taxable Income x T =
$44000 x 0.3 = $13200 Net Income = Taxable Income - Tax Amount = $44000 - $13200 = $30800
Profit Margin = Net Income / R = ($30800 / $500000) x 100 = 6.16 %

Specific ratios related to financial analysis

Ratio #6 Retention Rate

The retention rate, sometimes called the plowback ratio, is a financial ratio that measures the
amount of earnings or profits that are added to retained earnings at the end of the year. In other
words, the retention rate is the percentage of profits that are withheld by the company and not
distributed as dividends at the end of the year.
This is an important measurement because it shows how much a company is reinvesting in its
operations. Without a steady reinvestment rate, company growth would be completely
dependent on financing from investors and creditors.
In a sense the retention ratio is the opposite of the dividend payout ratio because it shows how
much money the company chooses to keep in its bank account; whereas, the dividend payout
ratio computes the percentage of profits that a company choose to distribute to its shareholders.
The plowback ratio increases retained earnings while the dividend payout ratio decreases
retained earnings.
Formula
The retention rate is calculated by subtracting the dividends distributed during the period from
the net income and dividing the difference by the net income for the year.

The numerator of this equation calculates the earnings that were retained during the period
since all the profits that are not distributed as dividends during the period are kept by the
company. You could simplify the formula by rewriting it as earnings retained during the period
divided by net income.

Specific ratios related to financial analysis

Analysis
Since companies need to retain some portion of their profits in order to continue to operate and
grow, investors value this ratio to help predict where companies will be in the future. Apple, for
instance, only started paying dividends in the early 2010s. Up until then, the company retained
all of its profits every year.
This is true about most tech companies. They rarely give dividends because they want to
reinvest and continue to grow at a steady rate. The opposite is true about established
companies like GE. GE gives dividends every year to it shareholders.
Higher retention rates are not always considered good for investors because this usually means
the company doesn't give as much dividends. It might mean that the stock is continually
appreciating because of company growth however. This ratio helps illustrate the difference
between a growth stock and an earnings stock.

Q 13
Ted's TV Company earned $100,000 of net income during the year and decided to
distribute $20,000 of dividends to its shareholders. Here is how Ted would calculate his
plowback ratio.

As you can see, Ted's rate of retention is 80 percent. In other words, Ted keeps 80 percent of
his profits in the company. Only 20 percent of his profits are distributed to shareholders.
Depending on his industry this could a standard rate or it could be high.

Specific ratios related to financial analysis

Ratio #6 Cash Coverage Ratio

The cash coverage ratio is useful for determining the amount of cash available to pay for a
borrower's interest expense, and is expressed as a ratio of the cash available to the amount of
interest to be paid. To show a sufficient ability to pay, the ratio should be substantially greater
than 1:1.
To calculate the cash coverage ratio, take the earnings before interest and taxes (EBIT) from
the income statement, add back to it all non-cash expenses included in EBIT (such as
depreciation and amortization), and divide by the interest expense. The formula is:
Earnings before Interest and Taxes + Non-Cash Expenses
Interest Expense

Q 14.
The controller of the Anderson Boat Company (ABC) is concerned that the company
has recently taken on a great deal of debt to pay for a leveraged buyout, and wants to
ensure that there is enough cash to pay for its new interest burden. The company is
generating earnings before interest and taxes of $1,200,000 and it records annual
depreciation of $800,000. ABC is scheduled to pay $1,500,000 in interest expenses in
the coming year. Based on this information, ABC has the following cash coverage ratio:
Solution:
$1,200,000 EBIT + $800,000 Depreciation
$1,500,000 Interest Expense
= 1.33 cash coverage ratio
The calculation reveals that ABC can pay for its interest expense, but has very little cash left
for any other payments.
There may be a number of additional non-cash items to subtract in the numerator of the
formula. For example, there may have been substantial charges in a period to increase
reserves for sales allowances, product returns, bad debts, or inventory obsolescence. If
these non-cash items are substantial, be sure to include them in the calculation. Also the
interest expense in the denominator should only include the actual interest expense to be
paid - if there is a premium or discount to the amount being paid, it is not a cash payment,
and so should not be included in the denominator.

Specific ratios related to financial analysis

Miscellaneous Questions related to Financial Ratios
Q1.
Gambit Golfs market-to-book ratio is currently 2.5 times and PE
ratio is 6.75 times. If Gambit Golfs common stock is currently
selling at $12.50 per share, what is the book value per share and
earnings per share?
Q2.
Leonatti Labs year-end price on its common stock is $35. The firm
has total assets of $50 million, the debt ratio is 65%, no preferred
stock, and there are 3 million shares of common stock outstanding.
Calculate the market-to-book ratio for Leonatti Labs.
Q3.
Leonatti Labs year-end price on its common stock is $15. The firm
has a profit margin of 8%, total assets of $25 million, a total asset
turnover ratio of 0.75, no preferred stock, and there are 3 million
shares of common stock outstanding. Calculate the PE ratio for
Leonatti Labs.
Q4.
Use the following financial statements for Lake of Egypt Marina to
answer problems

Lake of Egypt Marina, Inc.

Balance Sheet as of December 31, 2007 and 2008
(in millions of dollars)
Assets
2007 2008

Current assets:

2007

2008

Current liabilities :

Cash and marketable

$

securities
40

Liabilities & Equity

Accounts receivable
80
90

Accrued wages and

65
110

75
115

taxes
Accounts payable

43

Specific ratios related to financial analysis

Inventory
80
Total
210

190

200

$ 365

$ 390

Fixed assets:

Notes payable
Total

Long-term debt:

70
$ 193

$ 280

$ 300

Gross plant and

equipment

$ 471

Less: Depreciation
shares) $
5 $

$ 580
100

110

Preferred stock (5 million

Net plant and

equipment

Stockholders equity:

Common stock and

$ 371

$ 470

paid-in surplus

50

(65 million shares)

65

65
Other long-term assets
Total
330

$ 420

49

$ 520

Retained earnings

Total
Total assets

$ 785

$ 910

$ 312
Total liabilities and equity

242
$ 400
$ 785

$ 910

Lake of Egypt Marina, Inc.

Income Statement for Years Ending December 31, 2014 and 2015
(in millions of dollars)
2014
Net sales (all credit)

2015
$ 432

$ 515

Specific ratios related to financial analysis

Less: Cost of goods sold

200

260
Gross profits

232

255

20

22

Less: Depreciation
Earnings before interest and taxes (EBIT)

212

233
Less: Interest
Earnings before taxes (EBT)

30

33

182

200

Less: Taxes

55

57

Net income

$ 127

$ 143

Less: Preferred stock dividends

Net income available to common stockholders

$ 122

138
Less: Common stock dividends

$ 65

$ 65

Addition to retained earnings

$ 57

$ 73

Per (common) share data:

Earnings per share (EPS)

$1.877

Dividends per share (DPS)

Book value per share (BV)

$2.123

$1.000
$4.723

Market value (price) per share (MV)

$1.000
$6.077

$12.550

$14.750

Spreading the Financial Statements Spread the balance sheets and income
statements of Lake of Egypt Marina, Inc. for 2014 and 2015.
Spread the balance sheet:

Lake of Egypt Marina, Inc.

Balance Sheet as of December 31, 2014 and 2015

Specific ratios related to financial analysis

(in millions of dollars)
Assets
2014 2015

2007

Current assets:

2008

Current liabilities:

Cash and marketable

securities
4.40%

Liabilities & Equity

Accrued wages and

8.28%

8.24%

taxes

Accounts receivable 14.01 12.64

Accounts payable

Inventory

Notes payable

Total

24.21 21.98
46.50 42.86

Fixed assets:

10.19

9.89
8.92

Total

24.59

Long-term debt:

5.48%

35.67

8.79
23.08

32.97

Gross plant and

equipment

60.00 63.74

Less: Depreciation
shares)
0.63
0.55

Stockholders equity:

12.74 12.09

Net plant and

equipment

Common stock and

47.26 51.65

Other long-term assets

Total
36.26

Preferred stock (5 million

6.24

53.50 57.14

paid-in surplus
5.49

100.00% 100.00%

7.14

(65 million shares)

Retained earnings
Total

Total assets
100.00% 100.00%

8.28

30.83
39.74 43.95

Total liabilities and equity

Spreading the income statement:

Lake of Egypt Marina, Inc.

Income Statement for Years Ending December 31, 2014 and 2015

Specific ratios related to financial analysis

(in millions of dollars)
2014
Net sales (all credit)

2015

100.00%

Less: Cost of goods sold

100.00%

46.30

50.49
Gross profits
Less: Depreciation

53.70

49.51

4.63

4.27

Earnings before interest and taxes (EBIT)

49.07

45.24
Less: Interest
Earnings before taxes (EBT)

6.94

6.41

42.13

38.83

Less: Taxes

12.73

Net income

29.40%

11.07
27.76%

Calculating Ratios Calculate the following ratios for Lake of Egypt Marina, Inc.
as of year-end 2015.
a.
b.
c.
d.

Dividend payout ratio

Market-to-book ratio
PE ratio
Cash coverage ratio

Solutions:
1. Market-to-book ratio = 2.50 =

=> Book value per share

= $12.50/2.50 = $5.00
Book value per share

$12.50
Price-earnings (PE) ratio = 6.75 times = => Earnings per share =
$12.50/6.75 = $1.85
Earnings per share
2. Debt ratio = .65 = Total debt/$50m. => Total debt = .65 x $50m. = $32.5m.

=> Total equity = $50m. - $32.5m. = $17.5m.

Specific ratios related to financial analysis

=> Book value of equity = $17.5m./3/m. = $5.83333 per share
=> Market to book ratio = $35/$5.83333 = 6 times

3. Total asset turnover = .75 = Sales/$25m. => Sales = $25m. x .75 = $18.75m.

=> Profit margin = .08 = Net income/$18.75m. => Net income = .08 x
$18.75m. = $1.5m
=> EPS = $1.5m./3m. = $0.50 per share
=> PE ratio = $15/$0.50 = 30 times
4.
a. Dividend payout ratio

65/138=47.10%

b. Market-to-book ratio

14.750/6.077=2.43 times

c. PE ratio

14.750/2.123=6.95 times

d. Cash coverage ratio

(233+22)/33=7.73 times

35%
2.55 times
15.60 times
8.75 times