1

Actual 2009 and estimated 2010 financial statements

for the fiscal year ending December 31
(R million)
Change
2009 2010
(%)
Income statement
Revenue 4 750 5 140 7,6

Cost of goods sold 2 400 2 540

Sales, general and administrative expenses 1 400 1 550
Depreciation 180 210
Amortisation of goodwill 10 10
Operating profit 760 830 8,4
Interest expense 20 25
Income before tax 740 805
Tax 265 295
Net Income 475 510

Earnings per share 1,79 1,96 8,6

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
Shareholder’s equity 2100 2 200
Total assets 2 950 3 100

Book value per share 7,92 8,46

Annual dividend per share 0,55 0,60
 2

Notes:
1 The required rate of return is 19% per annum. Assume the required rate of
return also applies to free cash flow.
2 The current risk-free interest rate is 4% per annum. The risk premium is 3%.
3 Other information
JSE QBC Goods
P/E ratio 18,00 ?
Expected dividend growth rate 0,06 ?
Dividend yield 0,02 ?

4 Company tax rate is 40%.

Required:
1 List the three components of DuPont formula.
2 Calculate ROE for 2010 using the three components of the DuPont formula
3 Sustainable growth rate.
4 P/E ratio.
5 Weighted average cost of capital (WACC) based on book values.
6 Free cash flow to equity (FCFE)
7 Operating free cash flow (OFCF)(also called FCFF)
8 Expected intrinsic value of the company’s share.
9 Growth duration
10 Price/Book value (P/BV)
11 Price/Cash flow (P/CF)
12 Price/Sales (P/S)
 3

Answer:

1 ROE = Profit Margin x Asset turnover x Financial Leverage

Or

ROE = ROA x Financial leverage

Or

ROE = Net Income / Shareholders Equity

2 ROE = (510 / 5 140) x (5 140 x 3 100) x (3 100 x 2 200)

= 9,92% x 1,66 x 1,41
= 23,21%

Or

ROE = (510 / 3 100) + (3 100 / 2 200)

= 16,45% x 2 200 / 3 100
= 23,18%

Or

ROE = 510 / 2 200

= 23,18%

3 Sustainable growth rate:

g = ROE x RR
= 23,21 x (1 – (0,60 / 1,96))
= 16,10%

4 P/E:

P/E = (D1 / E1) / (k – g)

= 0,3061 / (0,19 – 0,1610)
= 10,56

D1 / E1 = 0,60 / 1,96 = 0,3061

5 WACC:
WACC= W Ek + W Di
= [(2 200 / 2 500) x 0,19] + [(300 / 2 500) x (8,33% x (1 – 0,4))]
= 16,72 + 0,60
= 17,32%
 4

6 Free cash flow to equity:

FCFE =
Net Income 510,00
+ Depreciation 210,00
+ Amortisation 10,00
= Cash flow from operations 730,00
- Capital Expenditure (210 + 70) -280,00
- Working capital change (700 + 600 - 600) – (680 + 570 – 550)* 0,00
= Free cash flow to equity (FCFE) 450,00
* Excluding cash

How would we determine the present value of this (FCFE) cash flow?:

FCFE / (1 + k)

How would we determine the value of equity?:

FCFE / (k – g FCFE)

7 Operating free cash flow (OFCF) (also called FCFF – Free Cash Flow to the
Firm)

Net Income 510,00

+ Depreciation 210,00
+ Amortisation 10,00
= Cash flow from operations 730,00
- Capital Expenditure (210 + 70) -280,00
+ Interest expense* +15,00
- Working capital change (700 + 600 - 600) – (680 + 570 – 550)** 0,00
= Free cash flow from operations (OFCF) 465,00
* Adjust for tax = 25 x (1-0.4) = 15.
** Excluding cash because that is what we want to determine.

How would we determine the present value of this (FCFF) cash flow?:

Present value of (expected) OFCF will be:

FCFF / (1 + WACC)

How would we determine the value of the firm?:

FCFF / (WACC – g FCFF)

EBIT may also be used as basis for the calculation.

8 E(V) = D1 / k – g
= 0,60 / (0,19 – 0,1610)
= 20,69.
 5

9 Growth duration

Dividend yield = 0,19 – 0,1610 = 0,0290

ln[(Pg / Eg) / (Pa / Ea)] = T x ln[(1 + Gg + Dg) / (1 + Ga + Da)]

ln[(10,56 / 18,00)] = T x ln[(1 + 0,1610 + 0,0290) / (1 + 0,06 + 0,02)]

T = ln (0,59) / ln (1,1019)
= -0,53 / 0,097
= -5,4979 years

Because it is negative, the company has to grow for 5,5 years before it will
reach the level of the industry.

10 Price/Book value ratio (P/BV) per share

P/BV = (ROE x payout ratio) / (r – g)

= [0,2321 x (0,6 / 1,96)] / (0,19 – 0,1610)
= 2,45
Or

P/BV = 20,69 / 8,46

= 2,45

11 Price/Cash flow ratio (P/CF) per share

P/CF = (Stock price in period t) / (FCFF per share)

= 20,69 / (465,00 / 260)
= 8,47

12 Price to sales (P/S)

Price / Sales = 20,69 / (5 140 / 260)

= 1,05

Or

Price/Sales = [Net Profit Margin x PE]

= [(510 / 5 140) x 10,56]
= 1,05

Or

Price/Sales = [Net Profit Margin x payout ratio] / k – g

= [(510 / 5 140) X 0,3061] / 0,0290
= 1,05
6