9
For Chapter the Investor
TO THE NET
1. a.
200
6
Disposal of discontinued operations
Net income
Diluted income (loss) per share:
Continuing operations
Discontinued operations
Disposal of discontinued operations
Net income
$ 0.74
(.03
)
$ 0.30
.33
$ 1.04
$
.01
.43
$ 1.48
(.03
)
(.08
)
$ 1.37
Discontinued operations
200
4
$ 1.65
(.03
)
(.10
)
$ 1.52
Earnings per common
Basic income (loss) per share:
Continuing operations
200
5
$
$
.31
$
.12
.69
(.02
)
.11
.29
.96
$
b. Price / Earnings Ratio
Market Price Per Share
Diluted Earnings Per Share Before Nonrecurring Items
2006
$39.09
=
1.48
26.41
2005
$24.43
.69
=
35.41
2004
$23.20
.31
=
74.84
c. Percentage of Earnings Retained
Net Income Before Nonrecurring Items All Dividends
Net Income Before Nonrecurring Items
2006
2005
$71,563 $8,736
$71,563
$62,827
=
$33,568 $9,116
$33,568
=
=
87.79%
=
72.84%
$71,563
$24,452
$33,568
8
.01
.43
2004
$10,700 $7,292
$10,700
$3,408
=
=
$10,700
9
31.85%
d. Dividend Payout
Dividends Per Common Share
Diluted Earnings Per Share Before Nonrecurring items
2006
$.20
$1.48
2005
$.20
$.69
2004
$.20
$.31
13.51%
28.99
%
64.52
%
e. Dividend Yield
Dividends per Common Share
Market price per Common Share
2006
$.20
$39.09
2005
$.20
$24.
43
2004
$.20
$23.
20
.51%
.82%
.86%
2. Motorola
2006
2005
$ (404,000,000)
$ 1,845,000,000
Other charges (income) $ 2
Gains on sales of
investments and
businesses, net
$4
2004
$ 149,000,000
$ 460,000,000
3. Boeing
2006
$
a. Diluted earnings per common share
b. Price/earnings ratio
$
$
=
31.2
8
10
2005
$3.19
2004
$2.24
$70.24
$51.90
= 22.02
= 23.17
$3.19
$2.24
c. Percentage of earnings retained
Net Income Before Nonrecurring Items All Dividends
Net Income Before Nonrecurring Items
2006
$2,206 $956
2005
$2,562
$820
$2,562
$2,206
$1,250
2004
$1,820
$648
$1,820
$1,74
2
$2,56
2
67.99
%
$2,206
56.66%
$1,17
2
$1,82
0
64.40
%
d. Dividend Payout
Dividends Per Common Share
Diluted Earnings Per Share Before Nonrecurring Items
2006
$1.25
$2.84
$.44
200
5
$1.
05
$3.
19
200
4
$.8
5
$2.
24
$.3
3
$.3
8
e. Dividend Yield
Dividends Per Common Share
Market Price Per Common Share
2006
$1.25
$88.84
1.41%
2005
$1.0
5
$70.
24
2004
$.85
1.49
1.64
$51.
90
11
%
%
12
4.
a. Total assets
2006
$215,666,000
2005
$172,759,000
b. Shareholders equity
$161,145,000
$81,012,000
c. Common stock shares issued and outstanding
15,734,000
12,789,000
d. Total capitalization
Shares issued and outstanding (a)
Market price (b)
(a) x (b) =
15,734,000
$31.59
$49,703,706
12,789,000
$16.95
$21,677,355
e. Total shareholders equity represents the book amount. Capitalization is equal to
shares issued and outstanding multiplied by the market price per share.
13
QUESTIONS
9 - 1.
Earnings per share is the amount of income earned on a share of common
stock during an accounting period.
9 - 2.
The Financial Accounting Standards Board suspended the reporting of
earnings per share for nonpublic companies.
9- 3.
Keller & Fink is a partnership. Earnings per share is a concept that only
applies to corporate income statements.
9 - 4.
Earnings per share is a concept that only applies to common stock. The
earnings per common share computation only uses earnings available to
common stockholders. To arrive at the income that applies to common stock,
preferred dividends are subtracted from net income in the numerator of the
ratio.
9 - 5.
Since earnings pertain to an entire year, they should be related to the common
shares outstanding during the year. The year -end common shares outstanding
may not be representative of the shares outstanding during the year.
9 - 6.
Less preferred dividends will be subtracted from net income in the numerator
of the earnings per share computation. This will increase earnings per share.
In practice, whether earnings per share will be increased or decreased
depends on the after-tax earnings that the firm would have from the funds
used to retire the preferred stock in relation to the dividend decrease.
9 - 7.
Stock dividends and stock splits do not provide the firm with more funds; they
only change the number of outstanding shares. Earnings per share should be
related to the outstanding common stock after the stock dividend or stock split.
9- 8.
Many firms try to maintain a stable percentage because they have a policy on
the percentage of earnings that they want retained for internal growth.
9- 9 .
Financial leverage is the use of financing with a fixed charge. Financial
leverage will magnify changes in earnings available to the common
shareholder. Its use is advantageous when a firm obtains a greater return on
the resources obtained than the rate of interest expense. Its use is
disadvantageous when a firm obtains a lower return on the resources obtained
than the rate of interest expense.
14
9-10.
If the interest rate rises, the degree of financial leverage will rise. For
example, suppose the firm has the following pattern of earnings with
$1,000,000 in long-term debt:
Earnings before interest and tax
Interest ($1,000,000 at 8%)
Earnings before tax
Degree of Financial Leverage
$ 1,000,000
80,000
$ 920,000
Income Before Interest and Tax
Earnings before tax
=
=
$1,000,000
$920,000
=
1.09
If the rate of interest rises to 12%, then the degree of financial leverage will be
as follows:
Earnings before interest and tax
Interest ($1,000,000 at 12%)
Earnings before tax
$ 1,000,000
120,000
$ 880,000
=
$ 1,000,000
880,000
=
Degree of financial leverage
1.14
The degree of financial leverage has risen.
9-11.
Investors attach a higher price to securities that they feel have higher
potential. This gives a higher price/earnings ratio.
9-12.
A relatively new firm often has a low dividend payout ratio because it needs
funds to establish itself (i.e. increase inventory, increase accounts receivable,
etc.).
A firm with a substantial growth record and/or substantial growth prospects
needs funds for expansion. They utilize them in this manner rather than paying
them out to the owners.
9-13.
A low dividend yield may indicate that the firm is retaining its earnings for
growth. The investor might expect to get his/her returns in the form of market
price appreciation.
15
9-14.
Book value is based on a mixture of valuation basis, such as historical costs.
Current value accounting should make book value closer to market.
9-15.
Stock options are a form of potential dilution of earnings. With the requirement
that stock option expense be recorded in the income statement, the dilution
will reduce earnings each year.
9-16.
A relatively small number of stock appreciation rights can prove to be a
material drain on future earnings and cash of a company because stock
appreciation rights are tied to the future market price of the stock.
9-17.
If the stock price decreases in relation to the prior year, then the estimate of
total compensation expense related to the stock appreciation rights will
decrease. The decrease in the estimate of total compensation expense will be
added to income for the current year.
16
PROBLEMS
PROBLEM 9-1
Degree of Financial Leverage
Earnings Before Interest and Tax
Earnings Before Tax
=
$975,000 + $70,000
$975,000
=
$1,045,000
$975,000
=
1.07
PROBLEM 9-2
a.
Degree of Financial Leverage
Earnings Before Interest and Tax
Earnings Before Tax
=
=
$1,000,000
$800,000
=
1.25
b. Prior earnings before interest and tax
10% increase
Adjusted income before interest and tax
Interest
Income before tax
Tax (50% rate)
Net income
Earnings will increase by 12.5% to $450,000
($400,000 x 112.5% = $450,000)
$ 1,000,000
100,000
$ 1,100,000
200,000
$ 900,000
450,000
450,000
c. $800,000
200,000
600,000
300,000
$300,000
This is a decline in profit of 25%, with a decline in earnings before interest and tax of
20%.
17
PROBLEM 9-3
a. 1. Percentage of Earnings Retained
=
Net Income before
nonrecurring items All
Dividends
Net Income before
nonrecurring items
2007
$ 31,200,000
2. Price/Earnings Ratio
2005
$ 29,800,000
21,700,000
910,000
$ 22,610,000
8,590,000
27.53%
Net income (A)
Less:
Common dividend
Preferred dividend
(B)
(A) (B) = (C)
(C) (A)
2006
$ 30,600,000
19,500,000
910,000
$ 20,410,000
10,190,000
33.30%
18,360,000
910,000
$ 19,270,000
10,530,000
35.34%
=
Market Price Per Share
Fully Diluted Earnings Per Share
2007
$12.80
$1.12
=
2005
$16.30
$1.27
= 11.43
3. Dividend Payout
2006
$14.00
$1.20
=
11.67
=
12.83
Dividends Per Common Share
Fully Diluted Earnings Per Share
2007
$0.90
$1.12
= 80.36%
4. Dividend Yield
=
2006
$0.85
$1.20
2005
$0.82
$1.27
= 70.83%
= 64.57%
Dividends Per Common Share
Market Price Per Common Share
2007
$0.90
$12.80
2006
$0.85
$14.00
2005
$0.82
$16.30
= 7.03%
=
6.07%
=
5.03%
18
5. Book Value Per Share =
Total Stockholders' Equity Preferred Stock Equity
Number of Common Shares Outstanding
2007
Total assets:
$1,280,100,000
Less:
Liabilities
(800,400,000)
Stockholders Equity
479,700,000
Less:
Nonredeemable
preferred stock
(15,300,000)
(A) Common stock
equity
$ $464,400,000
(B) Shares
outstanding end
of year
24,280,000
2006
$ 1,267,200,000
(A) (B)
$
$
$19.13
2005
$ 1,260,400,000
(808,500,000)
458,700,000
(799,200,000)
461,200,000
(15,300,000)
(15,300,000)
$ $443,400,000
$ $445,900,000
23,100,000
22,500,000
$19.19
$
$19.82
b. The percentage of earnings retained is decreasing. The related ratio, dividend
payout, is therefore increasing.
The price/earnings ratio has been relatively stable. The dividend yield has increased
and is relatively high. The market price per share is substantially below the book
value. It appears that this stock is being purchased for the relatively high dividend
and not for growth potential.
19
PROBLEM 9-4
a. 1. Percentage of Earnings Retained
=
Net Income before
nonrecurring items All
Dividends
Net Income before
nonrecurring items
2007
$ 9,100,000
2005
$ 16,500,000
(6,080,000)
$ 3,020,000
Net income (B)
Less:
Cash dividends (A)
2006
$ 13,300,000
(5,900,000)
$ 7,400,000
(6,050,000)
$ 10,450,000
(A) (B)
33.19%
2. Price/Earnings Ratio
=
55.64%
63.33%
Market Price Per Share
Fully Diluted Earnings Per Share
2007
$41.25
$2.30
=
2005
$29.00
$4.54
= 17.93
3. Dividend Payout
2006
$35.00
$3.40
=
10.29
= 6.39
Dividends Per Common Share
Fully Diluted Earnings Per Share
2007
200
6
$1.
90
$3.
40
$1.90
$2.30
= 82.61%
4. Dividend Yield
=
200
5
$1.
90
$4.
54
=
55.88%
=
41.85%
Dividends Per Common Share
Market Price Per Common Share
2007
$1.90
2006
$1.9
0
20
2005
$1.9
0
$41.25
$35.
00
$29.
00
= 4.61%
=
5.43%
=
6.55%
21
5. Book Value Per Share
=
Market Price Value
Ratio of Market Price to Book Value
2007
$41.25
120.5%
= $34.23
2006
$35.0
0
108.0
%
2005
$29.0
0
105.0
%
=
$32.41
=
$27.62
b. The percentage of earnings retained materially declined. The related ratio, dividend
payout, materially increased.
The price earnings ratio materially increased, which is difficult to explain, considering
the decline in earnings and the other ratios computed. The dividend yield has
declined each year, while the book value per share increased each year.
The increase in market price and the increase in price earnings ratio appears to be
explained by the increase in order backlog at year -end and the increase in net
contracts awarded.
22
PROBLEM 9-5
Simple Earnings Per Share
=
Net Income Preferred Dividends
Weighted Average Number of
Common Shares Outstanding
Year 1
$40,000 $22,500
38,000
Year 2
$42,000
$27,500
38,00
$0.46
$0.38
The decline in earnings per share is caused by the issuance of preferred stock.
PROBLEM 9-6
January 1, shares outstanding
July 1, two-for-one stock split
Adjusted shares outstanding for the year
50,000 shares
2
(A) 100,000
October 1 stock issue
10,000 shares
Proportion of year that the new shares were
outstanding
0.25
Weighted average for the new shares on an annual
basis
(B)
2,500
Denominator of the earnings per share
computation for the current year
(A) + (B) 102,500
PROBLEM 9-7
Revision of 2006 earnings per share:
2006 reported earnings per share
July 1, 2007 stock split
Adjusted 2006 earnings per share
December 31, 2007 stock split
Adjusted 2006 earnings per share
$ 2.00
x 0.5
$ 1.00
x 0.5
$ 0.50
Comparative Earnings Per Share
2007
2006
Earnings Per Share
$1.50
$.50
PROBLEM 9-8
a.
Net income
Preferred dividends
January 1, 2007 shares of common stock
outstanding
July 1, 2007 common stock issue, 1,000
shares x
Numerator
$ 35,000
(3,000)
20,000
$ 32,000
Earnings per share
b. From (a)
Less extraordinary gain
Recurring earnings per share
Denominator
500
20,500
$1.56
$ 32,000
5,000
$ 27,000
$1.32
20,500 shares
20,500
PROBLEM 9-9
a.
Numerator
$ 200,000
(10,000)
Net income
Preferred dividends
Common shares outstanding on
January 1
Common stock issue on July 1,
5,000 shares
Weighted average
Two-for-one stock split on
December 31
Denominator
20,000 shares
2,500 (5,000 x )
22,500
$ 190,000
2
45,000 shares
$190,000/45,000 shares = $4.22 per
share
b.
Current Year
Earnings per share reported
for the prior year
Two-for-one stock split on
December 31 of the current year
($8.00 x 0.5) = $4.00
Prior Year
$8.00
$4.00
Earnings per share computed
in (a) for the current year
$4.22
PROBLEM 9-10
a. 1. Percentage of Earnings Retained
Cash dividends
Preferred dividends
Total dividends
Net income (B)
Net income dividends (A)
Percentage of earnings
retained (A) (B)
=
Net Income before
nonrecurring items All
Dividends
Net Income before
nonrecurring items
2007
$0.80 x 25,380,000
$20,304,000
4,567,000
24,871,000
32,094,000
7,223,000
2006
$0.76 x 25,316,000
$19,240,160
930,000
20,170,160
31,049,000
10,878,840
22.51%
35.04%
2. Price/Earnings Ratio
Market Price Per Share
Fully Diluted Earnings Per Share
=
2007
2006
$12.94
$1.08
$15.19
$1.14
= 11.98%
3. Dividend Payout
=
=
13.32%
Dividends Per Common Share
Fully Diluted Earnings Per Share
2007
2006
$0.80
$1.08
= 74.07%
4. Dividend Yield
$0.76
$1.14
= 66.67%
Dividends Per
Common Share
Market Price Per
Common Share
=
2007
$0.80
$12.94
$0.76
$15.19
= 6.18%
5. Book Value Per Share
2006
=
5.00%
=
Common Equity
Common Shares
Outstanding
Total assets
Less: total liabilities
Less: nonredeemable preferred stock
Common equity (A)
Shares outstanding (B)
2007
$ 1,264,086,000
(823,758,000)
(16,600,000)
$ 423,728,000
+ 25,380,000
2006
$ 1,173,924,000
(742,499,000)
(16,600,000)
$ 414,825,000
+ 25,316,000
Book value per share (A) (B)
$16.70
$16.39
b. Having the percentage of earnings retained decline provides mixed feelings. It
implies that more is going to shareholders, but at the same time, earnings retained
for growth have diminished. The rise in the dividend payout ratio supports this
position.
The price/earnings ratio has declined as a result of the drop in price. This decline
indicates lower shareholder expectations but might also indicate a good time to buy.
Dividend yield is up, caused by the rise in dividends and more so by the drop in
price.
Book value per share is up. However, book value is above market, which shows that
the investors do not view the assets as worth their book value. This is not a good
sign.
Overall the signals are mixed. There is not enough information to determine if this is
a good investment.
PROBLEM 9-11
a. The major advantage of receiving stock appreciation rights instead of stock options
is that the executive does not to have make a big cash outlay at the date of exercise,
but rather receives a payment for the share appreciation. This helps the executives
cash flow.
b. The related credit is to a liability under the stock appreciation plan that would
probably be classified as long-term, since exercise cannot occur until 2010.
c. In 2010, the company must pay off the liability related to the appreciation in cash.
For this problem, it is $30,000. In doing financial statement analysis, this future cash
flow, if material, must be considered. As in this case, the full impact may not be
apparent until the last year, if the market price rises sharply.
PROBLEM 9-12
a.
b.
3
2
Common shareholders equity divided by the number of common chares
outstanding gives book value per share.
Book Value Per Share
=
Total Stockholders Equity
Preferred Stock (At Liquidation)
Number of Common Shares Outstanding
$1,000,000 + $1,500,000 + $500,000 - $1,100,000
150,000 Shares
=
$12.67
PROBLEM 9-13
a. 1. Degree of Financial Leverage =
Earnings Before Interest and Tax
Earnings Before Tax
2007:
$110,500 +
$9,500
$110,500
= 1.09
2006:
$107,700 +
$6,600
$107,700
= 1.06
2005:
$100,450 +
$6,800
$100,450
= 1.07
2004:
$124,100 +
$6,900
$124,100
= 1.06
2003:
$119,000 +
$7,000
$119,000
= 1.06
2. Earnings Per Common Share
2007:
Continuing operations
Extraordinary gain
* Should be used in primary
analysis.
2006:
$2.57
2005:
$2.36
2004:
$3.23
2. *
67
.
69
3.
$
36
$
2003:
$2.81
3. Price/Earnings Ratio
=
Market Price Per Share
Fully Diluted Earnings
Per Share
2007:
$24.
00
$2.6
7
= 8.99
2006:
$22.
00
$2.5
7
= 8.56
2005:
$21.
00
$2.3
6
= 8.90
2004:
$37.
00
$3.2
3
= 11.46
2003:
$29.
00
$2.8
1
= 10.32
4. Percentage of Earnings Retained
=
Net Income before
nonrecurring items All
Dividends
Net Income before
nonrecurring items
2007:
$77,500 $3,920 $91,640
$77,500
= (23.30%)
2006:
$74,400 $6,100 $66,410
$74,400
= 2.54%
2005:
$68,350 $6,400 $60,900
$68,350
= 1.54%
2004:
$93,700 $6,600 $84,970
$93,700
= 2.27%
2003:
$81,600 $6,000 $81,200
$81,600
= (6.86%)
5. Dividend Payout
=
Dividends Per Common Share
Fully Diluted Earnings Per Share
2007:
$3.
16
$2.
67
= 118.35%
2006:
$2.
29
$2.
57
= 89.11%
2005:
$2.
10
$2.
36
= 88.98%
2004:
$2.
93
$3.
23
= 90.71%
2003:
$2.
80
$2.
81
= 99.64%
6. Dividend Yield
=
Dividends Per Common Share
Market Price Per Common Share
2007:
$3.1
6
$24.
00
= 13.17%
2006:
$2.2
9
$22.
00
= 10.41%
2005:
$2.1
0
= 10.00%
$21.
00
2004:
$2.9
3
$37.
00
= 7.92%
2003:
$2.8
0
$29.
00
= 9.66%
7. Book Value Per Share
=
Total Stockholders Equity Preferred Stock Equity
Number of Common Shares Outstanding
2007:
$489,000
$49,000
29,000
= $15.17
2006:
$514,000
$76,000
29,000
= $15.10
2005:
$516,000
$80,000
29,000
= $15.03
2004:
$517,000
$82,000
29,000
= $15.00
2003:
$508,000
$75,000
29,000
= $14.93
8. Materiality of Options
2003 - 2007:
=
Stock Options Outstanding
Number of Shares of Common Stock Outstanding
$1,000,0
00
29,000,0
00
= 3.45%
b. This firm has a very low degree of financial leverage.
Earnings from continuing operations and the price/earnings ratio have been
relatively stable.
Practically all of the earnings have been paid out in dividends, thus, book value per
share has only increased slightly.
The dividend yield is very high. The market price has declined substantially.
Options outstanding appear to be immaterial.
In general, the investor analysis is positive if the investor wants high dividends.
Growth prospects do not appear to be good.
PROBLEM 9-14
a.
3
2007
----
EPS previously reported
2007 declared a 4-for-1 stock split
2007 reported .30 EPS
b.
.20
.20
4
New EBIT
Prior EBIT
$
$
(a)
Financial leverage
(b)
(a) x (b)
c.
2005
$.80
.25
.25
.30
2006
$100
4
2,000,000
1,000,000
1,000,000
1.5
$
1,500,000
Adjust the shares in 2007 by adding 10% additional shares. Divide the
previous number of shares for 2007 by the new number of shares. This
is the percentage of the previous reported earnings per share that should
be reported as the adjusted earnings per share. For illustration, assume
the following;
(A)
Previous shares
10% stock dividend
(B)
New number of shares
(A) (B)
100,000/110,000
100,0
00
10,00
0
110,0
00
= .909
d.
3
The price/earnings ratio usually reflects investors opinions of the future
prospects for the firm.
e.
4
Degree of financial leverage gives a perspective on risk in the capital
structure.
f.
3
The earnings per share ratio is computed for common stock.
g.
2
Increasing financial leverage can be a risky strategy from the viewpoint of
stockholders of companies having low and falling profits.
h.
1
10% x 1.3 = 13%
i.
2
Dividend yield represents dividends per common share in relation to
market price per common share.
j.
5
Book value per share may not approximate market value per share
because of all of the reasons listed.
CASES
CASE 9-1 CASEYS
a. 1. 50,189,812 (Shares of common issued)
2. 50,189,812 (Shares of common stock outstanding)
3. Weighted average shares outstanding is used to compute earnings per share
b. Diluted earnings per share
c. Net earnings from continuing operations
Note: Net earnings should also be considered so that all items are considered.
d. Book value
2005
$469,137,000
50,189,812
2004
$439,794,0
00
50,015,862
$9.35
$8.79
e. Dividend payout
2005
$9,771
$42,532
23.0%
2004
$6,47
9
$37,8
97
17.1%
2003
$4,96
3
$41,0
12
12.1%
Note: This is computed slightly different than the book formula.
CASE 9-2 MET-PRO SPLIT
a. 1. $5,888,379 (No change)
2. Earnings per share
Basic and diluted were the same earnings per share.
0.95 x 3/4 = 0.71
3. Common stock
a. Par value 0.10
b. Shares authorized
18,000,000 (No change)
c. Shares issued
7,226,303 x 4/3 = 9,635,071
CASE 9-3 STOCK-BASED COMPENSATION
(This case provides the opportunity to review the materiality of employee stock options
on three separate companies in two widely different industries.)
a. Yes. Industries that are high tech tend to have substantial stock-based
compensation. We would expect Boeing and Google to use stock-based
compensation more extensively than Kroger.
b. Materiality of Options =
Net Income Before Nonrecurring
Net Income Before Nonrecurring
Items Not Including Option Expense Items InIncluding Option Expense
Net Income Before Nonrecurring Items Not Including Option Expense
Kroger Co.
($1,115 + $72) $1,115
$1,115 + $72
=
$72
$1,259
=
5.72
%
Boeing Company
$2,206 + $743 $2,206
$2,206 + $743
=
$743
$2,249
=
25.19
%
Google
$3,077,446 + $17,629 + $287,485 +
$59,389 + $93,597 13,077,446
$3,077,446
=
$458,100
$3,077,446
=
14.89
%
As expected, Boeing and Google have material stock based compensation.
CASE 9-4 BIG BOY
(This case provides an opportunity to compute several of the ratios introduced in this
chapter.)
a. 1. Degree of Financial Leverage
2007
$16,191,584
=
Earnings Before Interest and Tax
Earnings Before Tax
2006
$16,268,22
7
$13,496,88
5
$13,519,413
= 1.20
= 1.21
2. Price/Earnings Ratio
2007
$31.95
=
Market Price Per Share
Diluted Earnings Per Share, Before Nonrecurring Items
2006
$25.
70
$1.7
8
$1.78
= 17.95
=
14.4
4
3. Percentage of Earnings Retained =
2007
Net Income Before Nonrecurring
Items All Dividends
Net Income Before Nonrecurring Items
2006
$9,267,556 $2,239,666
$9,159,765
$2,229,327
$9,159,765
$9,267,556
$7,027,890
=
$9,267,556
4. Dividend Yield
$6,930,438
=
$9,159,765
75.83%
=
Dividends Per Common Share
Market Price Per Common Share
2007
$.44
1.38
=
%
$31.95
5. Book Value Per Share
2006
$.44
1.71
=
%
$25.70
=
Total Stockholders Equity Preferred Stock Equity
Number of Common Shares Outstanding
2007
$107,869,775
7,568,680 2,445,764
$107,869,775
=
5,122,916
75.66%
$21.06
2006
$100,681,436
7,521,930 2,447,323
$100,681,436
=
5,074,607
$19.84
b. 1. Degree of financial leverage appears to be high.
2. Price/earnings ratio has increased without an earnings per share increase. This
could indicate risk to the stock price.
3. Percentage of earnings retained was steady and would likely be reasonable.
4. Material decline in dividend yield. Dividend yield is relatively low.
5. Book value per share increased moderately.
c. 1. Special Items
2007 Gains on sale of assets
2006 Gains on sale of assets
2005 Gains on sale of assets
Life insurance benefits in excess of cash surrender value
2.
2007
Net Earnings
Estimated tax rate:
$4,251,857
=
$13,519,413
$ 9,267,556
31.45%
Special item, net of tax
$250,069 x (1 31.45%)
2006
Net Earnings
Estimated tax rate:
$4,337,120
=
$13,496,885
$ 171,422
$ 9,096,134
$ 9,159,765
32.13%
Special item, net of tax
$567,987 x (1 32.13%)
$ 385,493
$ 8,774,272
3.
2005
Net Earnings
Estimated tax rate:
$4,913,997
=
$19,654,822
$ 14,740,825
25.00%
Gains on sale of assets $
86,921
Life insurance gain
$ 4,440,000
$ 4,526,921
Special item, net of tax
$4,526,921 x (1 25.00%)
$ 3,395,191
$ 11,345,634
d. 1.
Frischs Restaurants
Consolidated Statement of Earnings (In part)
Vertical Common-Size
2007
100.0%
Sales
Gross profit
Operating profit
10.0
5.6
2006
100.0
%
9.8
5.6
2005
100.0
%
10.9
6.5
2. Gross profit declined substantially. Operating profit declined materially.
CASE 9-5 NEWS, NEWS, NEWS
(This case provides an opportunity to view five-year horizontal and vertical commonsize analysis. There are also three ratios.)
a. 1.
The Gannett Co.
Selected Financial Data
Horizontal Common-Size Analysis
2006
200
5
200
4
200
3
200
2
Net operating revenues:
Newspaper advertising
132.6
Newspaper circulation
112.5
Broadcasting
110.8
All other
145.1
Total
126.9
127
.4
108
.8
95.
5
126
.5
120
.0
119
.4
104
.9
106
.5
118
.2
115
.1
106
.7
102
.7
93.
3
110
.1
104
.5
100
.0
100
.0
100
.0
100
.0
100
.0
2. Only the all other area had a substantial increase. Newspaper advertising had a
moderate increase. Broadcasting and newspaper circulation had minor
increases.
b. 1.
The Gannett Co.
Selected Financial Data
Vertical Common-Size Analysis*
2006
200
5
200
4
200
3
200
2
Net operating revenues:
Newspaper advertising
66.9
Newspaper circulation
16.3
Broadcasting
10.6
67.
9
16.
6
9.7
66.
4
16.
7
11.
3
5.6
100
.0
65.
3
18.
0
10.
9
5.7
100
.0
64.
0
18.
4
12.
2
5.5
100
.0
All other
Total
6.2
100.0
5.8
100
.0
* There are some rounding differences.
2. None of the areas had substantial changes considering that the time period was
from 2002 2006. Newspaper advertising increase was offset by newspaper
circulation decrease.
c.
1.
The Gannett Co.
Selected Financial Data
Horizontal Common-Size
2006
200
5
200
4
200
3
200
2
125
.1
118
.3
317
.1
125
.1
116
.8
108
.1
158
.8
116
.5
105
.3
103
.8
112
.9
105
.2
100
.0
100
.0
100
.0
100
.0
Operating expenses:
Cost and expenses
136.5
Depreciation
Amortization of
intangible assets
114.4
Total
136.0
463.9
2. Only amortization of intangible assets increased materially considering the time
period.
d. 1.
The Gannett Co.
Selected Financial Data
Vertical Common-Size*
2006
2005
200
4
200
3
200
2
95.4
4.0
95.
1
4.5
95.
3
4.4
95.
1
4.7
95.
1
4.8
.4
100
.0
.2
100
.0
.2
100
.0
.2
100
.0
Operating expenses:
Cost and expenses
Depreciation
Amortization of
intangible assets
Total
.6
100.0
* Some rounding differences
2. Cost and expenses make up over 95% of total operating expenses. There were
no major changes in this area.
e. 1. Degree of Financial Leverage
2006
$1,719,482 + $288,040
$1,719,482
$2,007,522
$1,719,482
116.8
Earnings Before Interest and Tax
Earnings Before Tax
=
2005
$1,817,855 +
$210,625
$1,817,855
$2,028,4
80
$1,817,8
55
111.6
2004
$1,960,183 +
$140,647
$1,960,183
$2,100,8
30
$1,960,1
83
107.2
2. Price/Earnings Ratio
2006
$60.46
$4.90
12.34
3. Dividend Yield
2006
$1.20
$60.46
1.98%
=
Market Price Per Share
Diluted Earnings Per Share, Before Nonrecurring Items
2005
$61.
09
$4.9
2
2004
$80.
69
$4.8
4
12.4
2
16.6
7
=
Dividends Per Common Share
Market Price Per Common Share
2005
$1.1
2
$61.
09
2004
$1.0
4
$80.
69
1.83
%
1.29
%
f. Degree of financial leverage increased substantially.
The price/earnings ratio decreased materially.
The dividend yield increased materially.
CASE 9-6 EAT AT MY RESTAURANT INVESTOR VIEW
(This case represents an opportunity to review these restaurants from an investor view).
a. Yum Brands, Inc.
All-inclusive degree of financial leverage
This ratio increased slightly; would likely be considered to be moderate.
Diluted earnings per share before nonrecurring items
2006
$2.92
2005
$2.55
Material increase in earnings per share
Percentage of earnings retained
2006
2005
82.52%
83.86%
Substantial amount of earnings retained
Dividend yield
2006
2005
1.47%
.95%
Dividend yield increased materially
Price / Earnings Ratio
2006
2005
20.09
18.38
Moderate increase in price / earnings ratio
Market price per share
2006
2005
$58.65
$46.88
Material increase in market price per share
Panera Bread
All-inclusive degree of financial leverage
No financial leverage
Diluted earnings per share before nonrecurring items
2006
2005
$1.84
$1.65
Material increase in earnings per share
Percentage of earnings retained
100% of earnings retained
Dividend yield
No dividend yield
Price / Earnings Ratio
Material decrease in price/earnings ratio, but it is still very high.
Market price per share
Material decrease in market price per share
Starbucks
All-inclusive degree of financial leverage
Very little financial leverage
Diluted earnings per share
2006
2005
$.73
$.61
Material increase in diluted earnings per share
Percentage of earnings retained
100% of earnings retained
Dividend yield
No dividend yield
Price / Earnings Ratio
Material decrease in price/earnings ratio, but it is still very high.
Market price per share
2006
2005
$34.05
$50.10
Material decrease in market price per share
b. All-inclusive degree of financial leverage
Yum Brands, Inc. has a moderate all-inclusive degree of financial leverage.
Starbucks has very little and Panera Bread did not have an all-inclusive degree of
financial leverage.
Diluted Earnings Per Share Before Nonrecurring Items
All these companies had a material increase. The most substantial percentage
increase was at Starbucks, followed by Yum Brands, Inc. and then Panera Bread.
Percentage of Earnings Retained
Yum Brands, Inc. had a substantial amount of earnings retained. Panera Bread and
Starbucks retained all of their earnings.
Dividend Yield
Yum Brands, Inc. increased dividend yield materially, but the yield would be
considered to be moderate. Panera Bread and Starbucks did not pay a dividend.
Price/Earnings Ratio
Moderate increase for Yum Brands, Inc. Material decrease for Panera Bread and
Starbucks. Yum Brands, Inc. price/earnings ratio is substantially lower than for
Panera Bread and Starbucks.
Market Price Per Share
Material increase for Yum Brands, Inc. Material decrease for Panera Bread and
Starbucks.
c. Based on the above, which firm would you select?
Would select Yum Brands, Inc.; influenced partially by the lower price/earnings ratio
along with the dividend.
THOMSON ONE
1. This Thomson One exercise, using the Merck & Company, provides for comments
on several market factors including price earnings ratio, market capitalization, and
cash dividends.
2. This Thomson One exercise uses Apple Computer, Dell Computer, and HewlettPackard. Factors considered are earnings per share, forecasts and price/earnings
ratio.