Question 3

Suppose that you are considering investing in one of two companies, each in the same industry. The most recent income statements for each company and other relevant information are as follows:

Income Statements
	McGregor Company	Fasnacht Company
Sales	R50 000 000	R40 000 000
Less: Cost of goods sold	30 000 000	26 000 000
Gross margin	R20 000 000	R14 000 000
Less: Selling and administrative expenses	15 000 000	7 000 000
Operating income	R5 000 000	R7 000 000
Less: Interest expense	1 000 000	3 000 000
Income before taxes	R4 000 000	R4 000 000
Less: Income tax	1 360 000	1 360 000
Net income	R2 640 000	R2 640 000
Retained earnings	8 000 000	6 000 000
	R10 640 000	R8 640 000
Less: Dividends	840 000	1 040 000
Ending retained earnings	R9 800 000	R7 600 000
Other relevant information
Average total assets	R20 000 000	R22 000 000
Average common equity	R10 000 000	R13 000 000
Average common shares	1 000 000 shares	1 200 000 shares
Average preferred shares*	300 000 shares	100 000 shares
Market price per common share	R5.00	R9.80

* For both McGregor and Fasnacht, the preferred dividend is R1 per share

Required:

Note: Round answers to two decimal places.

3.1 Calculate the following for each company:

a. Earnings per share

b. Dividend yield

c. Dividend payout ratio

d. Price-earnings ratio

e. Return on assets

f. Return on stockholders equity

3.2 In which of the two companies would you invest? Explain.