Professional Documents
Culture Documents
ABHINAV PUJARA
ANSHUL SHARMA
RAGHAV ARORA
RAJAT JAIN
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INTRODUCTION TO THE CASE
Bryan Szafranski observed that the demand of denim is almost inelastic in USA since
there is very less fluctuations in the demand of denim
He discovered that DENTEX is the primary manufacturer of denim in North Carolina
The major specialisation of DENTEX is denim and produces a modest amount of other
type of cloths
The market share of DENTEX is 33% of the total denim market in terms of sales
(considering both domestic and abroad)
There has been a steadily increase in per-share earnings and dividends with the exception
of 2001 (the most recent year) and 1998 which impressed him
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Consolidated Balance sheet of Dentex at the end of year 2000 and 2001
Consolidated Statement of Income for the year ending 2000 and 2001
Details of Earnings per share and Dividend per share from 1991 to 2001
Industry Averages for selected ratios
EXHIBIT 1
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6
CONTINUED
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EXHIBIT 2 8
DETAILS OF EARNINGS PER SHARE AND DIVIDEND PER SHARE
SHOULD HE
BUY THE
SHARE OF
DENTEX?
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QUESTION 1
The liquidity ratios of DENTEX is better than the industry averages which indicates that
the amount as well as the quality of its current assets is better than that of the industry
Average collection period of DENTEX is also better than the industry which shows better
recovery from the debtors
Inventory turnover ratio is also better which could signify how fast the company is able to
sell inventory. But here, it can also imply insufficient inventory which is indicated by
8.5% reduction in sales in 2001 compared to 2000. However, we must see if the
reduction in sales is due to firm specific reasons like insufficient inventory or due to
macro factors like slowdown.
Fixed Asset turnover ratio is DENTEX is very less than the industry which is a result of
lower sales in the recent period.
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The much lower debt ratio of the company signifies that company is not taking
the risk of greater financial leverage to multiply its profits. Therefore, the profits
can be expected to remain stable
All the Profitability ratios of DENTEX are much better than that of the industry
in spite of the fact that the earnings of the company has fallen 32% this year
Greater interest coverage ratio implies that the company is strong enough the
meet its fixed payments well on time.
Net profit margin of the company is also better than the industry
Both the return on Assets and return on equity are so much better than the
industry which indicates that the company is able to generate greater % of the
profits on the capital invested.
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Therefore on the basis of the ratio analysis, the fundamentals of the company
are good.
The company is financially sound and is better than that of the industry.
The company is better in terms of its
Liquidity position
• Solvency Position
• Profitability position
• Efficiency
Therefore, we should buy the stock on the basis of the ratio analysis
However, the fact that the earnings and sales of the company has declined
considerably in the current year should be taken care of. The reason for the
decline in the earnings should be analysed.
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QUESTION 2
What is the firm's current pay out ratio compared to its historical payout ratio?
Historical pay out ratio of DENTEX is the arithmetic mean of last 10 year’s pay out
ratios
Earnings per share Dividends per share Payout ratio
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2001 5.87 2.20 37.47%
2000 8.82 2.00 22.67%
1999 7.49 1.80 24.03%
1998 6.21 1.60 25.76%
1997 6.75 1.35 20.00%
1996 4.90 0.95 19.38%
1995 3.97 0.75 18.89%
1994 2.51 0.70 27.89%
1993 1.58 0.55 34.81%
1992 1.33 0.51 38.35%
1991 1.00 0.50 50.00%
Historical pay out ratio of DENTEX is 28.18%. The current year’s pay out ratio is so much higher than the
historical pay out ratio.
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QUESTION 3
What are the annual growth rates in the earnings per share and the dividend?
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Earnings per Annual Growth Dividends per Annual Growth rate
share rate in EPS share in Dividends
Is there any reason to believe that the firm has changed its dividend policy?
Yes, the current year’s pay out ratio (37.47%) is so much higher than the average
historical pay out of 28%. The earnings have decreased but the dividend per share
has increased.
One of the reason behind high pay out ratio can be a huge amount of cash reserves
with the company which increased by 360% from $5000 in 2000 to $23000 in 2001.
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QUESTION 5
Risk is affected by many factors. How may each of the following affect the firm-
specific (unsystematic) risk associated with Dentex?
a) The firm’s geographical location
b) Its product line
c) Its use of debt financing
d) Foreign competition
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The firm’s geographical location:
The location of the firm contributes a lot in the firm specific risk
An American firm undertakes a risk different from an Indian or a UK firm even if
all other factors are considered as constant.
The demand of the product differs from country to country. It can also differs
from one state to another.
Generally, the demand of denim in US is inelastic compared to UK or India. US
companies generally follows a casual dress code (with jeans) at their work place
compared to India which follows a formal dress code at workplace.
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Product Line:
Choosing the right product line is very important, what product to launch when to
launch are some of the questions management needs to answer.
Adding a new product line that shows a considerable growth in the next years
will provide a huge opportunity for growth and profits.
Moreover, if the existing product line as a whole gets on a declining phase, the
firm will suffer a lot.
The denim industry has an inelastic demand. Therefore, the demand of denim
products are expected to remain stable.
Therefore, the earnings of DENTEX are expected to remain stable for the next
few years.
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Use of debt financing:
Usage of debt to finance operations increases the credit risk for the firm,
principal amount along with coupon payments need to be made to the lenders
which puts an additional burden on the company and risk for equity shareholders
increases and they will have to be compensated for that. Additional risk that the
firm undertakes from the financial leverage can result in a huge reduction in
profits from a small reduction in EBIT.
Currently, there is less financial leverage due to which the percentage decline in
Net income in the current year is almost equal to the percentage decline in EBIT.
The earnings of the firm has remained volatile. For some of the years, it has
increased considerably while for some years, it has reduced at a significant level.
However, the payout ratio has remained stable for last few years. Therefore, to
ensure stable payout ratio, the company has to adjust the dividend distributed to the
earnings per share. Therefore, the dividends have remained volatile too.
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QUESTION 8
If the beta coefficient were 0.8 and the sustainable growth is assumed to be 4%,
should the stock be purchased if the risk free rate is 3.5% and the anticipated
return on the market is 9.5%?
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Using CAPM, we will calculate the required rate of return (k)
Beta Coefficient (β)= 0.8
Risk free rate of return (RF) = 3.5%
Market Return (Rm) = 9.5%
k = RF + β (Rm - RF) = 3.5 + 0.8 (6) = 8.3%
Sustainable growth rate (g) = 4%
ANY QUESTIONS?