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Income Statement
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

December December December 3-Year
1995 1996 1997 Average

Financial Statistics
COGS as % of sales 77.59% 79.07% 77.96% 78.24%
SG&A 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

December December December
1995 1996 1997

Balance Sheet
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
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15
Chapter 14




Table 14.12 Smilewhite Corporation: Financial Statements”Yearly Data ($000 Except
Per-Share Data)


December December December
1995 1996 1997

Income Statement
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

December December December 3-Year
1995 1996 1997 Average

Financial Statistics
COGS as % of sales 70.00% 68.00% 66.53% 68.10%
SG&A 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

December December December
1995 1996 1997

Balance Sheet
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
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16 Web Problems




9. CFA Examination Level II
CFA
®
In her forecast of 1998 earnings per share for QuickBrush Company, Janet Ludlow has made the
assumptions shown in Exhibit 14.2:
Construct a 1998 projected income statement for OuickBrush using the percent-of-sales forecast-
ing method based on 1997 data in Table 14.11 and the assumptions in Exhibit 14.2 below. [6 minutes]


Exhibit 14.2 Forecast Assumptions: Quickbrush 1998 EPS


Revenue Will rise 30% from 1997
Cost of goods sold (as % of sales) 3-year historical average
Selling, general, and administrative expense (as % of sales) 3-year historical average
Depreciation and amortization 2% of 1997 property, plant,
and equipment
Interest expense Zero
Tax rate 34%
Shares outstanding No change




10. CFA Examination Level II
CFA
®
Janet Ludlow™s firm requires all its analysts to use a two-stage dividend discount model (DDM) and
the capital asset pricing model (CAPM) to value stocks. Using the CAPM and DDM, Ludlow has
valued QuickBrush Company at $63 per share. She now must value SmileWhite Corporation.
a. Calculate the required rate of return for SmileWhite using the information in Table 14.13 and the
CAPM. Show your work. [6 minutes]
Ludlow estimates the following EPS and dividend growth rates for SmileWhite:
First 3 years: 12 percent per year
Years thereafter: 9 percent per year
b. Estimate the intrinsic value of SmileWhite using the data from Table 14.12 and Table 14.13 and
the two-stage DDM. Show your work. [12 minutes]
c. Recommend QuickBrush or SmileWhite stock for purchase by comparing each company™s
intrinsic value with its current market price. Show your work. [6 minutes]
d. Describe one strength of the two-stage DDM in comparison with the constant-growth DDM.
Describe one weakness inherent in all DDMs. [6 minutes]


Table 14.13 Valuation Information: December 1997


QuickBrush SmileWhite
Beta 1.35 1.15
Market price $45.00 $30.00
Intrinsic value $63.00 ?


Notes:
Risk-free rate 4.50%
Expected market return 14.50%
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17
Chapter 14



11. CFA Examination Level II
CFA
®
The information in Exhibit 14.3 comes from the 1997 financial statements of QuickBrush Company
and SmileWhite Corporation:
Determine which company has the higher quality of earnings by discussing each of the three
notes. [9 minutes]

Exhibit 14.3 Notes to the 1997 Financial Statements


QuickBrush SmileWhite
Goodwill The company amortizes goodwill The company amortizes goodwill
over 20 years. over 5 years.
Property, plant, and equipment The company uses a straight-line The company uses an accelerated
depreciation method over the depreciation method over the
economic lives of the assets, economic lives of the assets,
which range from 5 to 20 years which range from 5 to 20 for
for buildings. buildings.
Accounts receivable The company uses a bad debt The company uses a bad debt
allowance of 2 percent of accounts allowance of 5 percent of
receivable. accounts receivable.


Note: Use Tables 14.14, 14.15, and 14.16 for Questions 12 and 13.


12. CFA Examination Level II
CFA
®
A company that Jones is researching is Mackinac Inc., a U.S.-based manufacturing company. Mack-
inac has released its June 2001 financial statements, which are shown in Tables 14.14, 14.15, and 14.16.
Jones is particularly interested in Mackinac™s sustainable growth and sources of return.
a. Calculate Mackinac™s sustainable growth rate. Show your calculations. [4 minutes]
Note: Use June 30, 2001, year-end balanced sheet data rather than averages in ratio calculations.
b. Name each of the five components in the extended DuPont System and calculate a value for each
component for Mackinac. [10 minutes]
Note: Use June 30, 2001, year-end balance sheet data rather than averages in ratio calculations.


Table 14.14 Mackinac Inc. Annual Income Statement for the year ended June 30, 2001
(In Thousands, Except Per-Share Data)


Sales $250,000
Cost of goods sold 125,000
Gross operating profit $125,000
Selling, general, and administrative expenses 50,000
Earnings before interest, taxes, depreciation, $ 75,000
and amortization (EBITDA)
Depreciation and amortization 10,500
Earnings before interest and taxes (EBIT) $ 64,500
Interest expense 11,000
Pretax income $ 53,500
Income taxes 16,050
Net income $ 37,450
Shares outstanding 13,000
Earnings per share (EPS) $ 2.88
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18 Web Problems




Table 14.15 Mackinac Inc. Balance Sheet as of June 30, 2001 (In Thousands)


Current Assets
Cash and equivalents 20,000
Receivables 40,000
Inventories 29,000
Other current assets 23,000
Total current assets $112,000
Noncurrent Assets
Property, plant, and equipment $145,000
Less: accumulated depreciation (43,000)
Net property, plant, and equipment $102,000
Investments 70,000
Other noncurrent assets 36,000
Total noncurrent assets $208,000
Total assets $320,000

Current Liabilities
Accounts payable $ 41,000
Short-term debt 12,000
Other current liabilities 17,000
Total current liabilities $ 70,000

Noncurrent Liabilities
Long-term debt $100,000

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