Financial Case Of Deanna Perez Fashions Inc.

1.The financial strength of Deanna Perez Fashions in comparison to the industry can be found by a relative comparison of its Current and TIE ratios to the industry averages. Both of these averages show the lack of their ability, relative to the industry to cover expenses. DPF’s current ratio, an indicator of the extent to which claims of short-term creditors are covered by current assets, is much lower than the industry average, suggesting that it’s liquidity position is relatively weak. The DPF’s TIE ratio of 1.5 is also very low in comparison to the industry average of 3.5. This shows that for DPF, relative to the industry they have less leeway in the amount operating income can decline before the firm is unable to meet the annual interest costs. DPF has been getting weaker in recent years. Their Current and TIE ratios were, in 1985, at par with the industry. DPF’s financial weakness is likely to have a binding effect on the dividend policy. The corporation will be forced to hold onto retained earnings, instead of paying them out, in order to protect themselves from bankruptcy costs and legal action.
2. Do investors prefer dividends or do they prefer companies to retain earnings? This is a question that is very much unresolved. It is very hard to understand dividends. Three explanations keep coming up. The first one is that dividends are irrelevant. In other words investors only care about total returns. They don’t care whether their total return comes from all dividends or all capital gains or a little of both (this comes from MM). The second argument is that dividends are taxed at higher rates then capital gains and therefore cannot be viewed in favor over capital gains. This could suggest that companies that do pay a dividend have a lower stock price. The third explanation is that dividends may provide investors with an idea about a firm’s future earnings strength. Large dividend increases can cause the stock price to go up, while dividend cuts can send a stock price down. So if investors are using the changes in dividend policies as indications about upcoming corporate ability to pay the dividend and its continued prospects, this price fluctuation says nothing about preferences for dividends and capital gains.

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4. Earnings over the last 15 years have on a average been growing at a rate of 6.9% – found by 14.00 EPS ’95 / 6.86 EPS ’80 = 2.04-1=1.04 EPS g total /15 yrs.= 0.069 or 6.9% average Dividend growth. The P/E ratio for DFP from 1980 to 1995 has been 1%- 5% points higher than that of the industry. The M/B ratio has been any where from 5%-16.5% points higher respectively, than that of the industry. What this means is that even though EPS growth was not spectacular, it was consistently improving at about the same rate as the industry and investors have been trading the stock at what is a good premium to the rest of the industry, it would appear that shareholders are satisfied with the dividend policy in its current state. Their stock has on average been returning 10.7% annually for the past 15 years-found by 287/110 = 2.609-1 = 1.609/15 yrs. = 0.107 or 10.7% annually.
5. Yes DFP’s management should be very concerned about the signaling theory that could occur if the dividend policy is altered. If the company were to decide to reduce the dividend it could very well send a signal to investors that the company will not be earning as much as needed to pay a higher dividend. It could also be seen by investors that the company has some good NPV projects in the pipeline and it would be beneficial to reduce the payout ratio, but it is very difficult to say how the investors will react to this and it is more likely to be negative than positive in accordance with the first view. If the company is to purchase stock back this could be considered a good signal by investors that management thinks the stock is cheap. However, in this case DFP is considered a take over target and if management buys back stock, it