Investments, tenth edition

Income Statement

December 

2011

December 

2012

December 

2013

Revenue

$3,480

$5,400

$7,760

Cost of goods sold

2,700

4,270

6,050

Selling, general, and admin. expense

500

690

1,000

Depreciation and amortization

       30

       40

       50

  Operating income (EBIT)

$   250

$   400

$   660

Interest expense

         0

         0

         0

  Income before taxes

$   250

$   400

$   660

Income taxes

       60

     110

     215

  Income after taxes

$   190

$   290

$   445

Diluted EPS

$  0.60

$  0.84

$  1.18

Average shares outstanding (000)

317

346

376

Financial Statistics

December 

2011

December 

2012

December 

2013

3-Year 

Average

COGS as % of sales

77.59%

79.07%

77.96%

78.24%

General & admin. as % of sales

14.37

12.78

12.89

13.16

Operating margin

7.18

7.41

8.51

Pretax income/EBIT

100.00

100.00

100.00

Tax rate

24.00

27.50

32.58

Balance Sheet

December 

2011

December 

2012

December 

2013

Cash and cash equivalents

$   460

$     50

$   480

Accounts receivable

540

720

950

Inventories

300

430

590

Net property, plant, and equipment

     760

  1,830

  3,450

 Total 

assets

$2,060

$3,030

$5,470

Current liabilities

$   860

$1,110

$1,750

  Total liabilities

$   860

$1,110

$1,750

Stockholders’ equity

  1,200

  1,920

  3,720

  Total liabilities and equity

$2,060

$3,030

$5,470

Market price per share

$21.00

$30.00

$45.00

Book value per share

$  3.79

$  5.55

$  9.89

Annual dividend per share

$  0.00

$  0.00

$  0.00

 Table 19A 

 QuickBrush Company financial statements: yearly data ($000 except per-share data) 

bod61671_ch19_635-677.indd   671

bod61671_ch19_635-677.indd   671

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

Visit us at www

.mhhe.com/bkm

672 

P A R T   V

 Security 

Analysis

   6.      a.   Mulroney recalled from her CFA studies that the constant-growth discounted dividend model 

was one way to arrive at a valuation for a company’s common stock. She collected current 

dividend and stock price data for Eastover and Southampton, shown in  Table 19E . Using 11% 

as the required rate of return (i.e., discount rate) and a projected growth rate of 8%, com-

pute a constant-growth DDM value for Eastover’s stock and compare the computed value for 

 Eastover to its stock price indicated in  Table 19F .    

    b.   Mulroney’s supervisor commented that a two-stage DDM may be more appropriate for com-

panies such as Eastover and Southampton. Mulroney believes that Eastover and Southampton 

Income Statement

December 

2011

December 

2012

December 

2013

Revenue

$104,000

$110,400

$119,200

Cost of goods sold

72,800

75,100

79,300

Selling, general, and admin. expense

20,300

22,800

23,900

Depreciation and amortization

      4,200

      5,600

      8,300

  Operating income

$    6,700

$    6,900

$    7,700

Interest expense

         600

         350

         350

  Income before taxes

$    6,100

$    6,550

$    7,350

Income taxes

      2,100

      2,200

      2,500

  Income after taxes

$    4,000

$    4,350

$    4,850

Diluted EPS

$      2.16

$      2.35

$      2.62

Average shares outstanding (000)

1,850

1,850

1,850

Financial Statistics

December 

2011

December 

2012

December 

2013

3-Year 

Average

COGS as % of sales

70.00%

68.00%

66.53%

68.10%

General & admin. as % of sales

19.52

20.64

20.05

20.08

Operating margin

6.44

6.25

6.46

Pretax income/EBIT

91.04

94.93

95.45

Tax rate

34.43

33.59

34.01

Balance Sheet

December 

2011

December 

2012

December 

2013

Cash and cash equivalents

$    7,900

$    3,300

$    1,700

Accounts receivable

7,500

8,000

9,000

Inventories

6,300

6,300

5,900

Net property, plant, and equipment

    12,000

    14,500

    17,000

 Total 

assets

$  33,700

$  32,100

$  33,600

Current liabilities

$    6,200

$    7,800

$    6,600

Long-term debt

  

 

9,000

  

 

4,300

  

 

4,300

  Total liabilities

$  15,200

$  12,100

$  10,900

Stockholders’ equity

    18,500

    20,000

    22,700

  Total liabilities and equity

$  33,700

$  32,100

$  33,600

Market price per share

$    23.00

$    26.00

$    30.00

Book value per share

$    10.00

$    10.81

$    12.27

Annual dividend per share

$      1.42

$      1.53

$      1.72

 Table 19B 

 SmileWhite Corporation financial statements: yearly data ($000 except per-share data) 

bod61671_ch19_635-677.indd   672

bod61671_ch19_635-677.indd   672

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

Visit us at www

.mhhe.com/bkm

  C H A P T E R  

1 9

 Financial 

Statement 

Analysis 

673

could grow more rapidly over the next 3 years and then settle in at a lower but sustainable rate 

of growth beyond 2017. Her estimates are indicated in  Table 19G . Using 11% as the required 

rate of return, compute the two-stage DDM value of Eastover’s stock and compare that value 

to its stock price indicated in  Table 19F .   

    c.   Discuss advantages and disadvantages of using a constant-growth DDM. Briefly discuss how 

the two-stage DDM improves upon the constant-growth DDM.     

   7.  In addition to the discounted dividend model approach, Mulroney decided to look at the price–

earnings ratio and price–book ratio, relative to the S&P 500, for both Eastover and Southampton. 

Mulroney elected to perform this analysis using 2010–2014 and current data.

     a.   Using the data in  Tables 19E  and  19F , compute both the current and the 5-year (2010–2014)  

average relative price–earnings ratios and relative price–book ratios for Eastover and 

 Southampton (i.e., ratios relative to those for the S&P 500). Discuss each company’s current 

relative price–earnings ratio compared to its 5-year average relative price–earnings ratio and 

each company’s current relative price–book ratio as compared to its 5-year average relative 

price–book ratio.  

    b.   Briefly discuss one disadvantage for each of the relative price–earnings and relative price–

book  approaches  to  valuation.     

2009

2010

2011

2012

2013

Income Statement Summary

Sales

$5,652

$6,990

$7,863

$8,281

$7,406

Earnings before interest and taxes (EBIT)

$   568

$   901

$1,037

$   708

$   795

Interest expense (net)

    (147)

    (188)

    (186)

    (194)

    (195)

Income before taxes

$   421

$   713

$   851

$   514

$   600

Income taxes

(144)

(266)

(286)

(173)

(206)

Tax rate

      34%

       37%

       33%

       34%

       34%

Net income

$   277

$   447

$   565

$   341

$   394

Preferred dividends

      (28)

      (17)

      (17)

      (17)

        (0)

Net income to common

$   249

$   430

$   548

$   324

$   394

Common shares outstanding (millions)

196

204

204

205

201

Balance Sheet Summary

Current assets

$1,235

$1,491

$1,702

$1,585

$1,367

Timberland assets

649

625

621

612

615

Property, plant, and equipment

4,370

4,571

5,056

5,430

5,854

Other assets

     360

     555

     473

     472

     429

Total assets

$6,614

$7,242

$7,852

$8,099

$8,265

Current liabilities

$1,226

$1,186

$1,206

$1,606

$1,816

Long-term debt

1,120

1,340

1,585

1,346

1,585

Deferred taxes

1,000

1,000

1,016

1,000

1,000

Equity–preferred

364

350

350

400

0

Equity–common

  2,904

  3,366

  3,695

  3,747

  3,864

Total liabilities and equity

$6,614

$7,242

$7,852

$8,099

$8,265

 Table 19C 

 Eastover Company ($ million, except shares outstanding) 

bod61671_ch19_635-677.indd   673

bod61671_ch19_635-677.indd   673

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

Visit us at www

.mhhe.com/bkm

674 

P A R T   V

 Security 

Analysis

    8.  Mulroney previously calculated a valuation for Southampton for both the constant-growth and 

two-stage DDM as shown below:

Constant-Growth Approach

Two-Stage Approach

$29

$35.50

    Using only the information provided and your answers to CFA Problems 5–7, select the stock 

(EO or SHC) that Mulroney should recommend as the better value, and justify your selection.  

    9.  In reviewing the financial statements of the Graceland Rock Company, you note that net income 

increased while cash flow from operations decreased from 2013 to 2014.

     a.   Explain how net income could increase for Graceland Rock Company while cash flow from 

operations decreased. Give some illustrative examples.  

    b.   Explain why cash flow from operations may be a good indicator of a firm’s “quality of 

earnings.”     

   10.  A firm has net sales of $3,000, cash expenses (including taxes) of $1,400, and depreciation of 

$500. If accounts receivable increase over the period by $400, what would be cash flow from 

operations?  

   11.  A company’s current ratio is 2.0. Suppose the company uses cash to retire notes payable due 

within 1 year. What would be the effect on the current ratio and asset turnover ratio?  

   12.  Jones Group has been generating stable after-tax return on equity (ROE) despite declining oper-

ating income. Explain how it might be able to maintain its stable after-tax ROE.  

2009

2010

2011

2012

2013