10. Application Exercise, Vertical Module
Financial leverage, operating profitability and growth financing
A firm has invested 400 in capital employed and generate sales of 500 for an operating income (EBIT) of 80.
Its financial strategy consists in no debt and 100% equity financing.
Profits are taxed at 40%, the firm distributes half of its profits and ambitions growing in the future at the annual rate of 10%.
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Question 1 of 7
1. Question
Calculate the net earnings (EAT)
CorrectIncorrectHint
Net earnings = EBIT – interest expenses (but no debt…) – taxes
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Question 2 of 7
2. Question
Calculate the Return-On-Equity (ROE)
CorrectIncorrectHint
ROE = net earnings / equity, it’s the return attributable to shareholders
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Question 3 of 7
3. Question
Calculate the sustainable growth rate
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Question 4 of 7
4. Question
Compare the sustainable growth rate and the target growth. Consequence?
CorrectIncorrectHint
If CE growth is greater than sustainable growth, then…
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Question 5 of 7
5. Question
The firm decides to raise a financial debt of 100 at the interest rate of 5%. Which ROE is generated with the new financial structure?
CorrectIncorrect -
Question 6 of 7
6. Question
With the new financial structure, did you solve the growth financing issue?
CorrectIncorrectHint
If CE growth is greater than sustainable growth, then…
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Question 7 of 7
7. Question
Which pay-out ratio (or distribution rate) might balance sustainable and target growth rates, for a debt level of 100 (with the ROE calculated in question 5)?
CorrectIncorrectHint
You have to calculate ‘d’ (pay-out) so that 10% = ROE * (1 – d)