(Adapted from 1999 CFA Level I1 exam) Scott Kelly is reviewing MasterToy”s financial statements in order to estimate its sustainable growth rate. Using the information presented in Exhibit 18- 1,
A. i. Identify the three components of the DuPont formula.
ii. Calculate the ROE for 1999 using the three components of the DuPont formula.
iii. Calculate the sustainable growth rate for 1999
Kelly has calculated actual and sustainable growth for each of the past four years and finds in each year that its calculated sustainable growth rate substantially exceeds its actual growth rate.
B. Cite one course of action (other than ignoring the problem) Kelly should encourage Master Toy to take, assuming the calculated sustainable growth rate continues to exceed the actual growth rate.
| EXHIBIT 18-1 Master Toy Inc. Actual 1998 and Estimated 1999 Financial Statements For N Ending December 31 ($ millions, except per-share data) | |||
| 1998 | 1999e | Change (%) | |
| Income Statement | |||
| Revenue | $4,750 | $5,140 | 8.2 |
| Cost of goods sold | $2,400 | $2,540 | |
| Selling, general, and administrative | 1,400 | 1,550 | |
| Depreciation | 180 | 210 | |
| Goodwill amortization | 10 | 10 | |
| Operating income | $760 | $830 | 9.2 |
| Interest expense | 20 | 25 | |
| Income before taxes | $740 | $805 | |
| Income taxes | 265 | 295 | |
| Net income | $475 | $510 | |
| Earnings per share | $1.79 | $1.96 | 9.5 |
| Average shares outstanding (millions) | 265 | 260 | |
| Balance Sheet | |||
| Cash | $400 | $400 | |
| Accounts receivable | 680 | 700 | |
| Inventories | 570 | 600 | |
| Net property, plant, and equipment | 800 | 870 | |
| Intangibles | 500 | 530 | |
| Total assets | $2,950 | $3,100 | |
| Current liabilities | $550 | $600 | |
| Long-term debt | 300 | 300 | |
| Total liabilities | $850 | $900 | |
| Stockholders” equity | 2100 | 2.200 | |
| Total liabilities and equity | $2,950 | $3,100 | |
| Book value per share | $7.92 | $8.46 | |
| Annual dividend per share | $0.55 | $0.60 | |
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