Quickbrush has little ability to increase its

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QuickBrush has little ability to increase its sustainable growth – plowback already equals 100%. SmileWhite could increase its sustainable growth by increasing its plowback ratio. b. QuickBrush’s recent EPS growth has been achieved by increasing book value per share, not by achieving greater profits per dollar of equity. A firm can increase EPS even if ROE is declining as is true of QuickBrush. QuickBrush’s book value per share has more than doubled in the last two years. Book value per share can increase either by retaining earnings or by issuing new stock at a market price greater than book value. QuickBrush has been retaining all earnings, but the increase in the number of outstanding shares indicates that it has also issued a substantial amount of stock. 19-4
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10. a. ROE = operating margin × interest burden × asset turnover × leverage × tax burden ROE for Eastover (EO) and for Southampton (SHC) in 2002 are found as follows: profit margin = Sales EBIT SHC: EO: 145/1,793 = 795/7,406 = 8.1% 10.7% interest burden = EBIT profits Pretax SHC: EO: 137/145 = 600/795 = 0.95 0.75 asset turnover = Assets Sales SHC: EO: 1,793/2,104 = 7,406/8,265 = 0.85 0.90 leverage = Equity Assets SHC: EO: 2,140/1,167 = 8,265/3,864 = 1.80 2.14 tax burden = profits Pretax profits Net SHC: EO: 91/137 = 394/600 = 0.66 0.66 ROE SHC: EO: 7.8% 10.2% b. The differences in the components of ROE for Eastover and Southampton are: Profit margin EO has a higher margin Interest burden EO has a higher interest burden because its pretax profits are a lower percentage of EBIT Asset turnover EO is more efficient at turning over its assets Leverage EO has higher financial leverage Tax Burden No major difference here between the two companies ROE EO has a higher ROE than SHC, but this is only in part due to higher margins and a better asset turnover -- greater financial leverage also plays a part. c. The sustainable growth rate can be calculated as: ROE times plowback ratio. The sustainable growth rates for Eastover and Southampton are as follows: ROE Plowback ratio* Sustainable growth rate Eastover 10.2% 0.36 3.7% Southampton 7.8% 0.58 4.5% *Plowback = (1 – payout ratio) EO: Plowback = (1 – 0.64) = 0.36 SHC: Plowback = (1 – 0.42) = 0.58 19-5
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The sustainable growth rates derived in this manner are not likely to be representative of future growth because 2002 was probably not a “normal” year. For Eastover, earnings had not yet recovered to 1999-2000 levels; earnings retention of only 0.36 seems low for a company in a capital intensive industry. Southampton’s earnings fell by over 50 percent in 2002 and its earnings retention will probably be higher than 0.58 in the future. There is a danger, therefore, in basing a projection on one year’s results, especially for companies in a cyclical industry such as forest products. 11.
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QuickBrush has little ability to increase its sustainable...

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