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Questions and Answers
Why does the geometric average growth rate differ from the arithmetic average growth rate when calculating earnings per share (EPS)?
Why does the geometric average growth rate differ from the arithmetic average growth rate when calculating earnings per share (EPS)?
- The arithmetic average is always higher due to its simpler calculation.
- The geometric average only uses the starting and ending EPS values, ignoring intermediate years.
- The geometric average considers the compounded effects of growth, while the arithmetic average does not. (correct)
- The arithmetic average is more accurate when growth rates are volatile.
Johnson & Johnson had a return on equity (ROE) of 31.4% in 1992 and a dividend payout ratio of 36%. If the payout ratio remains constant, but the ROE is expected to drop to 25% in 1993 due to healthcare reform, what happens to the growth rate?
Johnson & Johnson had a return on equity (ROE) of 31.4% in 1992 and a dividend payout ratio of 36%. If the payout ratio remains constant, but the ROE is expected to drop to 25% in 1993 due to healthcare reform, what happens to the growth rate?
- The growth rate will decrease because of the lower ROE. (correct)
- The growth rate will increase because the company is retaining more earnings.
- The growth rate will be unpredictable without additional information.
- The growth rate will remain the same because the payout ratio is constant.
Eastman Kodak had Net Income of $1,080 million, Interest Expense of $550 million, Equity (Book Value) of $6,000 million, and Debt (Book Value) of $6,880 million. Assuming a corporate tax rate of 40%, what is the Return on Capital (ROC)?
Eastman Kodak had Net Income of $1,080 million, Interest Expense of $550 million, Equity (Book Value) of $6,000 million, and Debt (Book Value) of $6,880 million. Assuming a corporate tax rate of 40%, what is the Return on Capital (ROC)?
- About 21.15%
- About 16.32% (correct)
- About 25.77%
- About 10.15%
Thermo Electron's earnings per share grew from $0.67 in 1987 to $1.51 in 1992. Which calculation would give you the most accurate average growth rate?
Thermo Electron's earnings per share grew from $0.67 in 1987 to $1.51 in 1992. Which calculation would give you the most accurate average growth rate?
Johnson & Johnson's expected growth rate in 1993 was calculated to be negative. What does this imply for the company's earnings?
Johnson & Johnson's expected growth rate in 1993 was calculated to be negative. What does this imply for the company's earnings?
Eastman Kodak had a book value of equity of $6,000 million, total dividends of $660 million, and 330 million shares outstanding. What was the dividend per share?
Eastman Kodak had a book value of equity of $6,000 million, total dividends of $660 million, and 330 million shares outstanding. What was the dividend per share?
Thermo Electron's earnings per share (EPS) data from 1987 to 1992 is provided. If an analyst wants to project future EPS based on historical growth, which method would be suitable?
Thermo Electron's earnings per share (EPS) data from 1987 to 1992 is provided. If an analyst wants to project future EPS based on historical growth, which method would be suitable?
Johnson & Johnson's return on equity (ROE) is expected to drop from 31.4% to 25% due to healthcare reform, while maintaining a constant dividend payout ratio. What is the most likely action the company might take to mitigate the impact of the lower ROE on its growth rate?
Johnson & Johnson's return on equity (ROE) is expected to drop from 31.4% to 25% due to healthcare reform, while maintaining a constant dividend payout ratio. What is the most likely action the company might take to mitigate the impact of the lower ROE on its growth rate?
Kodak is considering selling its chemical division. How does this sale directly impact the calculation of the new Return on Assets (ROA) in the restructuring plan?
Kodak is considering selling its chemical division. How does this sale directly impact the calculation of the new Return on Assets (ROA) in the restructuring plan?
Kodak's restructuring involves paying down debt, which affects its bond rating and interest rate. How does the reduced interest rate primarily influence the calculation of the new expected growth rate?
Kodak's restructuring involves paying down debt, which affects its bond rating and interest rate. How does the reduced interest rate primarily influence the calculation of the new expected growth rate?
How does the change in Kodak's Debt/Equity ratio from 1.14 to 0.73, after the restructuring, affect the calculation of the new expected growth rate?
How does the change in Kodak's Debt/Equity ratio from 1.14 to 0.73, after the restructuring, affect the calculation of the new expected growth rate?
Kodak's unlevered beta is calculated using the market value of equity. Why is market value preferred over book value in this calculation?
Kodak's unlevered beta is calculated using the market value of equity. Why is market value preferred over book value in this calculation?
Computer Associates is currently in a high-growth phase. How would a decreased dividend payout ratio impact its expected growth rate, assuming all other factors remain constant?
Computer Associates is currently in a high-growth phase. How would a decreased dividend payout ratio impact its expected growth rate, assuming all other factors remain constant?
Computer Associates' return on assets (ROA) is 25% during its high-growth phase. What does this indicate about the company's ability to generate profits?
Computer Associates' return on assets (ROA) is 25% during its high-growth phase. What does this indicate about the company's ability to generate profits?
Computer Associates has a debt/equity ratio of 10% during its high-growth phase. What implications does this have for the firm's financial risk?
Computer Associates has a debt/equity ratio of 10% during its high-growth phase. What implications does this have for the firm's financial risk?
Computer Associates is expected to become a stable firm in ten years. Which of the following changes in financial characteristics is most likely to occur as the firm transitions to a steady state?
Computer Associates is expected to become a stable firm in ten years. Which of the following changes in financial characteristics is most likely to occur as the firm transitions to a steady state?
Flashcards
Arithmetic Average Growth Rate
Arithmetic Average Growth Rate
The average growth rate without considering compounding.
Geometric Average Growth Rate
Geometric Average Growth Rate
The average growth rate that considers compounding effects.
Retention Ratio
Retention Ratio
The proportion of earnings reinvested in the company.
Return on Equity (ROE)
Return on Equity (ROE)
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Sustainable Growth Rate
Sustainable Growth Rate
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Dividend Payout Ratio
Dividend Payout Ratio
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Expected Growth Rate
Expected Growth Rate
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Beta
Beta
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Return on Assets (ROA)
Return on Assets (ROA)
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Debt/Equity Ratio
Debt/Equity Ratio
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Unlevered Beta
Unlevered Beta
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Return on Assets
Return on Assets
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Study Notes
- These study notes cover the earnings per share growth of Thermo Electron, growth rate estimations for Johnson & Johnson, potential restructuring for Eastman Kodak, and growth rates for Computer Associates.
Thermo Electron Earnings Per Share (1987-1992)
- The following data represents the earnings per share of Thermo Electron from 1987 to 1992:
- 1987 EPS: $0.67
- 1988 EPS: $0.77
- 1989 EPS: $0.90
- 1990 EPS: $1.10
- 1991 EPS: $1.31
- 1992 EPS: $1.51
- Arithmetic average growth rate in earnings per share from 1987 to 1992: 17.68%.
- Geometric average growth rate in earnings per share from 1987 to 1992: 17.65%.
- The geometric average considers the compounded effects of growth, while the arithmetic average does not.
Johnson & Johnson Growth Rate Estimation
- In 1992, Johnson & Johnson had a return on equity of 31.4% and paid out 36% of its earnings as dividends.
- Net income was $1,625 million, and book value of equity was $5,171 million.
- The return on equity is expected to drop to 25% in 1993 due to healthcare reform, with the dividend payout ratio remaining unchanged.
- Retention Ratio: 64%
- Return on Equity: 1625/5171 = 31.4%
- Expected Growth Rate (based on 1992 numbers): 0.64 * 31.4% = 20.10%
- Growth Rate in 1993: ( $5,171* (.25 -.314)/ $1,625) + 0.64 * 0.25 = -4.37%
- Growth Rate After 1993: 0.64 * 0.25 = 16%
Eastman Kodak Restructuring Analysis
- In 1994, Eastman Kodak was examined for potential restructuring.
- Net Income (1993): $1,080 million
- Interest Expense (1993): $550 million
- Equity (Book Value): $6,000 million
- Debt (Book Value): $6,880 million
- Total Dividends Paid (1993): $660 million
- Stock Price: $63
- Shares Outstanding: 330 million
- Corporate tax rate: 40%
- Beta: 1.10
- Potential Restructuring Actions:
- Sell its chemical division, having a total book value of assets of $2,500 million and $100 million in earnings before interest and taxes.
- Use cash to pay down debt and improve its bond rating, reducing the interest rate to 7%.
- Reduce the dividend payout ratio to 50% and reinvest more into the business.
- Expected Growth Rate (1993 numbers remain unchanged):
- Retention Ratio: 1 - $660/$1080 = 0.3889
- Return on Assets: ($1080 + $550 * (1 - 0.4))/($6000 + $6880) = 10.95%
- Debt/Equity Ratio: (6880/6000) = 1.14
- Expected Growth Rate: 0.3889 (10.95% + 1.14 (10.95% - (550/6880) * (1 - 0.4)) = 7.00%
- Expected Growth Rate (with restructuring):
- Retention Ratio: 50%
- Total Assets: $6000 + $6880 - $2500 = $10.380.
- New Return on Assets: (1020 + 550 * (1 - 0.4))/10380 = 13.01%
- New Debt Equity Ratio = (4380/6000) = 0.73
- New Expected Growth Rate = 0.50 (13.01% + 0.73 (13.01% - 7%*(1 - 0.4))) = 9.72%
- Beta (before restructuring): 1.10
- Unlevered Beta: 1.10/(1 + (6880/(330 * $63)) * (1 - 0.4)) = 0.9178
- Beta (after restructuring): 0.9178 * (1 + (4380/(330 * $63)) * (1 - 0.4)) = 1.04
Computer Associates Growth Rate Analysis
- Computer Associates makes software that enables computers to run more efficiently. Financial characteristics:
- Return on Assets: 25%
- Dividend Payout Ratio: 7%
- Debt/Equity Ratio: 10%
- Interest rate on Debt: 8.5%
- Corporate tax rate: 40%
- Expected to become a stable firm in ten years.
- Industry averages for larger, more stable firms:
- Industry Average Return on Assets: 14%
- Industry Average Debt/Equity Ratio: 40%
- Industry Average Interest Rate on Debt: 7%
- Industry Average Dividend Payout ratio: 50%
- Expected Growth Rate (high-growth phase): 0.93 (25% + 0.10 (25% - 8.50% * (1 - 0.4)) = 25.10%
- The following changes are expected:
- ROC declines.
- Dividend payout ratio increases.
- Debt/Equity ratio increases.
- Interest rate on debt declines.
- Expected Growth Rate (stable growth phase): 0.5 (0.14 + 0.4 (0.14 - 0.07 * (1 - 0.4)) = 8.96%
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Description
Study notes on earnings per share growth for Thermo Electron, Johnson & Johnson growth rate estimations, potential restructuring for Eastman Kodak, and growth rates for Computer Associates. Includes EPS data and calculations.
