Question

The following information relates to two companies for the year to 31 March 20x5.

Income statement (extracts)

	Laurel plc		Hardy plc
	£000		£000
Trading profit before interest	350		600
Interest payable	100		0
Profit before tax	250		600
Taxation	100		220
Profit for the period	150		380
Proposed dividend per ordinary share	50p		45p
Market price per ordinary share at 31 March 20x5	£3.70		£20.10

Balance sheets (extracts)

	Laurel plc		Hardy plc
	£000		£000
Equity
Ordinary shares (£1.00 each)	200		200
Retained earnings	320		1,500
	520		1,700
Non-current liabilities
10% bank loan	1,000		0
	1,520		1,700

There were no changes in either the number of shares in issue or in the non-current liabilities during the year to 31 March 20x5.

1. Calculate the following ratios for both Laurel plc and Hardy plc for the year to 31 March 20x5.

   1. dividend yield

   2. ordinary dividend payout

   3. interest cover

   4. earnings per ordinary share

   5. price/earnings ratio

   6. gearing

2. Based on your answers above, which company would make the better long term investment?

Answer 1

$\begin{align*}\text{Dividend Yield}&=\frac{\text{Dividend Per Share}}{\text{Price Per Share}}\\\text{Laurel plc}&=\frac{\£ 0.50}{\£ 3.70}\\&=13.51\%\\\text{Hardy plc}&=\frac{\£ 0.45}{\£ 20.10}\\&=2.24\%\end{align*}$

$\begin{align*}\text{Ordinary Dividend Payout}&=\frac{\text{Dividend Per Share}}{\text{Earnings Per Share}}\\\text{Laurel plc}&=\frac{\£ 0.50}{\£ 0.75}\\&=66.67\%\\\text{Hardy plc}&=\frac{\£ 0.45}{\£ 1.90}\\&=23.68\%\end{align*}$

$\begin{align*}\text{Interest Cover}&=\frac{\text{EBIT}}{\text{Interest Payable}}\\\text{Laurel plc}&=\frac{\£ 350,000}{\£ 100,000}\\&=3.5\;\text{times}\\\text{Hardy plc}&=\frac{\£ 600,000}{\£ 0}\\&=\text{NA}\end{align*}$

$\begin{align*}\text{Earnings per ordinary share}&=\frac{\text{Profit for the Period}}{\text{Number of Shares Outstanding}}\\\text{Laurel plc}&=\frac{\£ 150,000}{200,000}\\&=0.75\;\text{per share}\\\text{Hardy plc}&=\frac{\£ 380,000}{200,000}\\&=1.9\;\text{per share}\end{align*}$

$\begin{align*}\text{Price to Earning Ratio}&=\frac{\text{Price per share}}{\text{Earnings per Share}}\\\text{Laurel plc}&=\frac{ 3.70}{0.75}\\&=4.93\;\text{times}\\\text{Hardy plc}&=\frac{20.10}{1.9}\\&=10.58\;\text{times}\end{align*}$

Company Hardy plc would make better long term investment as its price to earning is higher than Laurel plc.