Janet Ludlow is a recently hired analyst. After describing the electric toothbrush industry, her first report focuses on two companies, QuickBrush Company and SmileWhite Corporation, and concludes:

QuickBrush is a more profitable company than SmileWhite, as indicated by the 40% sales growth and substantially higher margins it has produced over the last few years. SmileWhite's sales and earnings are growing at a 10% rate and produce much lower margins. We do not think SmileWhite is capable of growing faster than its recent growth rate of 10% whereas QuickBrush can sustain a 30% long-term growth rate.

a. Criticize Ludlow's analysis and conclusion that QuickBrush is more profitable, as defined by return on equity (ROE), than SmileWhite and that it has a higher sustainable growth rate. Use only the information provided in Tables 19A and 19B. Support your criticism by calculating and analyzing:

• The five components that determine ROE.

• The two ratios that determine sustainable growth: ROE and plowback.

b. Explain how QuickBrush has produced an average annual earnings per share (EPS) growth rate of 40% over the last 2 years with an ROE that has been declining. Use only the information provided in Table 19A .

Table 19 A

Table B

Transcribed Image Text:

December December December Income Statement Selling, genera, and admin. expense Operating Income (EBIT) Average shares outstanding (000) December December December 3-Year Average 78.24% 13.16 77.9696 General & admin. as % of sales December December December share 104,000 $110,400 $119,200 Selling, genera and admin. expense 20,300 $ 6,900 Interest expense Income taxes Average shares outstanding (000) December December December 3-Year Financlal Statistics COGS as % of sales General & admin. as % of sales 66.53% 68.10% 20.08 34.01 Net property, plant, and equlpment $ 10,900 Stockholders' equity Total llablities and equity share Book value per share Annual dividend per share