(Example 4-5)Lennar Homes has the following current financial results ($000). Re
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Question
(Example 4-5)Lennar Homes has the following current financial results ($000).
Revenue $50,000 Assets $40,000
EAT $ 5,000 Equity $10,000
Dividends $ 2,000
On the average, other building companies pay about one tenth of their earnings in dividends, earn about ten cents on the sales dollar, carry assets worth about three months of sales, and finance one half of their assets with debt.
Use the sustainable growth rate concept to analyze Lennar's inherent ability to grow without selling new equity versus that of an average building company. Identify weak areas and suggest further analyses.
gs = (1-d) ´ ROS ´ T/A ´ Equity
Turnover Multiplier
= (1-d) x EAT/sales ´ sales/assets ´ assets/equity
= (1-d)EAT/equity
Lennar ____ = ______ x ________ x ________ x ________
Industry ____ = ______ x ________ x ________ x ________
Explanation / Answer
Lennar:
Return on sales ( ROS) = EAT / Revenue = $ 5,000 / $ 50,000 x 100 = 10%
Total asset turnover = Revenue / Assets = $ 50,000 /$ 40,000 = 1.25 times
Equity multiplier = Assets / Equity = $ 40,000 / $ 10,000 = 4
Dividend payout ratio = Dividends / EAT x 100 = $ 2,000 / $ 5,000 x 100 = 40%
Retention ratio = 1- Dividend payout ratio = 1 - 40% = 60%
Sustainable growth rate for Lennar = ROS x Total asset turnover x Equity multiplier x Retention ratio = (10% x 1.25 x 4 ) x 60% = 30% or 0.30
Industry:
Return on sales = 10 cents on the dollar = 10 %
Total asset turnover = Entire year's sales / Total Assets = 12 x / 3 x = 4 times, assuming that monthly sales dollars is $ x.
Equity multiplier = Total Assets / Equity = 2 ( since as much as assets are financed with debt)
Retention ratio = 90% ( If one-tenth of earnings are paid out as dividends, the remaining 9/10 is retained in the business)
Sustainable growth rate = (10% x 4 x 2 ) x 90% =72% or 0.72
Lennar has a lower total asset turnover, and too high an equity multiplier (financial leverage), and its dividend payout ratio is too high.
The much lower total asset turnover indicates that Lennar is unable to translate its investmet in assets into high levels of sales. Hence, the thrust should be on increasing its dollar sales. The high level of equity multiplier can lead to financial risk, and severe liquidity problems. Therefore, Lennar would be well advised to reduce its dividend payout ratio, retire a part of its debt, reduce its interest expense, and concentrate on increasing its marke share.
ROS Total Asset Turnover Equity Multiplier ROE Retention Ratio Sustainable Growth Rate Lenner 10% 1.25 4 50 % 60 % 30 % Industry 10 % 4 2 80 % 90 % 72 %Related Questions
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