Problems on Fundamental Analysis

Problem No: 1
The following are the Income Statement and the Balance Sheet (partial) of M/s. ABC
Limited for the accounting year 2008:
INCOME STATEMENT
Operating profit (EBIT)
Rs.8,36,000
Less: Interest charges
1,76,000
Profit before tax (PBT)
6,60,000
Less: Provisions for tax (30%)
1,98,000
Net Profit (PAT)
4,62,000
Less: Preference Dividend
20,000
Earnings for Equity Shareholders
4,42,000
Less: Dividend paid
1,96,000
Retained Earnings
2,46,000
BALANCE SHEET OF ABC LIMITED
5% Preference Share Capital (of Rs.100 each)
Equity Share Capital
(38,200 shares of Rs.10 each)
Total Share Capital
Add: Share Premium A/c
Profit & Loss A/c
Shareholders Fund
Add: Long-term Loans
Capital Employed

Rs.4,00,000
3,82,000
7,82,000
8,56,000
22,70,000
39,08,000
20,46,000
59,54,000

Additional Information:
i
ii

Market price of the share on 31.12.07 was Rs.80

No final dividend has been proposed.

You are required to analyze the profitability from the point of view of a prospective
investor.

Solution
PROFITABLITY RATIOS
1

Return on Investment (ROI) = Operating profit (EBIT) = 8,36,000/59,54,000 = 0.14

Total Capital employed

Earnings per share = EAIT& PD/ No. of equity shares = 4,42,000/38,300 = 11.57

Price earnings ratio = MPS / EPS = 80 / 11.57 = 6.91 times

Dividend per share = Total Dividend / No. of equity shares = 1,96,000 / 38,200 = 5.13

Dividend payout ratio = DPS / EPS = 5.13 / 11.57 = 0.44 or 44%

Retained earnings ratio = 1 Dividend payout ratio = 1 0.44 = 0.56 or 56%

Dividend yield = DPS / MPS = 5.13 / 80 = 0.0641 or 6.41%

Growth in EBIT = Retention rate x ROI = 0 .56 x 0.14 = 0.0784 or 7.84%

Problem No: 2

The financial details of the Light Company are given in the following table. Find out the
specific reason for the prices to stagnate between 1997 and 99.
Details
DPS
Payout rate
EPS
Book Value
Rate of return on equity
Effective Tax rate
Rate of return on assets

1999
Rs.1.62
53.80%
Rs.3.01
Rs.19.18
15.9%
67%
13.2%

1998
Rs.1.58
65.80%
Rs.2.40
Rs.17.68
13.6%
50%
14.9%

1997
Rs.1.42
39.30%
Rs.3.61
Rs.17.91
20.3%
61%
17.2%

1996
Rs.1.26
39.40%
Rs.3.20
Rs.15.65
20.4%
59%
18.1%

Profit Margin on sales

Gross Profit Margin
Total Assets Turnover
Financial Leverage
Effective interest rate
Market price of the share

7.7%
57.5%
1.70
1.59
6.5%
Rs.51

8.3%
56.1%
1.79
1.54
6.8%
Rs.50

9.9%
53.9%
1.73
1.47
6.3%
Rs.50

10.3%
52.6%
1.75
1.39
6.3%
Rs.36

Solution
ANALYSIS
In the given table, the dividend per share has increased over the years
The dividend payout has increased
The earnings per share fluctuates, it has declined from 1997 and showed slight
improvement in the year 1999
In spite of the dividends paid, the share prices languished around Rs.50
REASONS
The rate of return on assets has declined from 18.1% in 1996 to 13.2% in
1999
NOTE
[The return on assets is the end result of the mixture of events that take place
within the firm. The greater the return on assets, the higher the market value
for the firms share, other things remaining constant. Every firm tries to
maximize the return on the assets, because funds are employed in the form of
assets. The return on assets depends on the turnover of assets into sales or
intensity of utilization of assets in creating sales. Further, the return on assets
indicates the productivity of funds.]

The margin on sales has declined over the years. This may be due to the
competition in the market

CONCLUSION
These two specific reasons might have contributed for the share price
languishing at around Rs.50

Problem No:3
Following are data for Anand Products (Rs. In lakhs)
Particulars
Assets
Short term liabilities
8% Debentures
10% Bonds
Common stock (Rs.10)
Surplus
Revenues
Operating Expenses
EBIT
Interest
EBT
Taxes
Dividend
a

Rs. In
Lakhs
6,000
450
1,250
500
3,500
300
6,600
5,950
650
150
500
200
50

Find out the following ratios:

i
Asset turnover
ii
Effective interest rate
iii
Effective tax rate
iv
Debt/equity ratio
v
Dividend pay-out ratio
b What growth rate of EBIT can be expected?

Solution
I

RATIOS

Asset turnover ratio = Turnover / assets = 6600 / 6000 = 1.1 TIMES

Effective interest rate = Interest / Total Debt (short term liab. + Deb. + Bonds)

= {(8% on 1,250) + (10% on 500)} / {450 + 1,250 + 500}

= 150 / 2,200 = 0.07 or 7%
3

Effective tax rate = Tax paid / EBT = 200 / 500 = 0.4 or 40%

Debt-Equity ratio = Total Debt / Equity = 2,200 / 3,500 = 0.63

Dividend payout ratio = DPS / EPS = 0.14 / 0.86 = 0.16 or 16%

PROOF

II

DPS = Dividend paid / No. of equity shares = 50 / 350 = 0.14 (i.e., 3,500/10)

EPS = EAIT / No. of equity shares = 300 / 350 = 0.86

GROWTH RATE
Growth in EBIT = Retention rate x Return on assets = 0.84 x 0.11 = 0.0924 or 9.24%

PROOF
Retention rate = 1 Dividend pay-out ratio = 1 0.16 = 0.84

Return on assets (ROA) = EBIT / Total Assets = 650 / 6,000 = 0.11 or 11%

Problem No: 4
A naive investor wants to analyze the capital structure of a company. He has the
following information of ABC Company Limited:
Particulars
Long term debt (11%)
Preferred Stock (10%)
Common stock (RS.10)
Capital surplus
Retained earnings
Dividend paid

1990
12.27
0.13
0.01
5.67
33.93
3.005

1995
9.46
0.13
0.14
6.35
60.31
3.684

1998
11.19
0.12
12.6
6.19
125.2
10.08

The present price of the share in Mumbai Stock Exchange is Rs.450. There is a
rumor in the market that the ABC Company Limited may issue bonus shares shortly.
The investor wants the answers for the following:
a Is there any ground for such rumor?
b Is the capital structure sound?
c Is it proper to purchase the shares?
Analyze the given data and advise him.

Solution

The table above gives how ABC Company has raised its long-term funds; preparation of
common size statement will provide a clear answer to the question of the investor
(Figures in percentage)
Particulars

1990

1995

1998

Long term debt (11%)

23.59

12.38

7.21

Preferred stock (10%)

0.25

0.17

0.08

Common stock (par at Rs.10)

0.02

0.18

8.11

Capital Surplus

10.90

8.32

3.99

Retained earnings

65.24

78.95

80.61

Total

100.00

100.00

100.00

The retained earnings have increased from 58.50% in 1990 to 80.61% in 1998. The
bulging retained earnings provide ground for the rumour for bonus share. The
rumour may come true, if the company likes to reduce the retained earnings which
are a likely event.

b The actual figures give a picture that the debt portion has increased in 1998
compared to 1995. Debt has increased, but the amount of debt was modest, and the
company was able to double its capital structure in a short period of time. There is
no excessive debt in the capital structure.
c

The P/E ratio of the ratio can be compared:

EPS = Retained earnings + Dividend = (125.20 + 10.08) = 135.28 = Rs.107.35
Number of equity shares
(12.6 / 10)
1.26
Price-Earnings ratio = Market Price / EPS = Rs.450 / Rs.107.35 = 4.19 times
CONCLUSION
Since the price earnings ratio is low, there is every possibility of a rise in the price
and investor can buy this share