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 A and B. 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 TableA.

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Income Statement 2 Selling, general, and admin. expense Depredation and amortization expense Income taxes Average shares outstanding (000) 3-Year Average 78.24% 13.16 Financial Statistics COGS as % of sales General & admin. as % of sales Operating margin Pretax income/EBIT Cash and cash equivalents Net property, plant, and equipment Total liabilities and equity Market price per share $104,000 $110,400 $119,200 Selling, general, and admin. expense Average shares outstanding (000) 1,850 3-Year Average 66.53% 68.10% 20.05 20.08 General & admin. as % of sales Net property, plant, and equipment equity share