Financial Returns and Capital Constraints

Financial Returns and Capital Constraints

Introduction

Darden Restaurant Inc. is a multi-brand restaurant operating in the United States with its headquarters in Orlando. The company is home to great dining bistros known as Capital Grille and Eddie V’s Prime which sells seafood. It also owns casual dining bistros named, The Bahama Breeze, The Yard House, The Olive Garden and The Cheddar’s Scratch. It’s the largest full-service restaurant in the world.

DuPont Analysis

            DuPont equation breaks down Return on Equity into three segments and was named after DuPont Plc., which applied the equation in the 1920s (Almazari, 2012). They summarised the equation as profit margin multiplied by the asset turnover and multiplied with financial leverage which made it easy for one to highlight and understand points of change over time. Below is the equation and calculation of Return on Equity using DuPont;

ROE =             Net Assets   ×      Sale            ×       Total Assets

Sales            Total Assets        Shareholder’s Equity

Table 1. Financial Data for Darden Restaurant Inc., 2019.

Return on Equity = (713.4 ÷ 8,510.4) × (8,510.4 ÷ 5,892.8) × (5,892.8 ÷ 2,392.8)

=      0.0838   ×   1.4442 × 2.4627 = 0.298144 = 0.30

Profit Margin in DuPont Equation

This measures the profitability of a company and it is a pointer of how well a company is managing its costs and its strategy on pricing. This is computed by dividing net income with total sales (Almazari, 2012). This means if the income increases, each sale with bring more money to the organization leading to an increased general return on equity.

Asset Turnover in DuPont Equation

This measures the effectiveness of a firm to apply its asset in generating sales. Firms with little profit margins seem to have increased asset turnover and vice versa (Almazari, 2012). If asset turnover rises, a firm generates more sales per asset leading to increased general return on equity.

Financial Leverage in DuPont Equation

This is the sum of funds owed that a firm uses to fund its operations and is compared to the one sourced from shareholders or internally (Almazari, 2012). Increased leverage will lead to increased return on equity. This is a result of tax savings originating from interest payments which lead to increased return on equity.

Constant Growth Stock Valuation (CGSV)

This is a model used to calculate the true worth of an asset-based on future streams of dividends growing at a constant rate (Acheampong & Agalega, 2013). It is illustrated below;

P_o =     D_o (1+g)

(r – g)

Where; Do is the Current dividend = $ 3 per share

g is the constant growth of dividend = assumed to be 8%

r is the Cost of Capital of Equity = assumed to be 12%

P_o = is the intrinsic value of the share =

P_o = 3 (1+0.08) ÷ (0.12 – 0.08) = $ 81

The current stock price is $ 84.53. Based on the intrinsic value of $ 81, it means that the value of the share is overpriced as $ 81 is the true worth of the share.

This model assumes a firm is a going concern in perpetuity and the dividends paid will grow evenly in the foreseeable future (Acheampong & Agalega, 2013). In calculating the true worth of the financial asset, the model considers infinite sets of dividends and finds their present values by discounting them using the cost of capital of equity. This is then compared with the market share price to determine whether the asset is under-priced or overpriced.

This model has its limitations especially with the assumption that dividends per share grow at a constant rate. This is not common for firms to show a constant growth of dividends as a result of unpredicted financial successes or challenges (Acheampong & Agalega, 2013). Secondly, the relationship seen between growth rate and cost of capital is questionable because when the growth is high, the market price of the share will be negative thus making it worthless and when the two rates are equal then, the value of the stock will be infinity.

Capital Constraints of Darden Restaurant Inc.
            Darden operates in the Hospitality industry and as it is all over the globe business encounter various business challenges while establishing as well as when in operations and the key aspect is lack of adequate resources to start or run (Parker & Van Praag, 2006). Darden Restaurant is not any different especially at this time of Covid-19.

The main constraints of accessing capital are financiers being risk-averse and being hesitant to uncertainty. Additionally, lack of adequate tangible assets or strong financial pillar can lead to financing firms not to finance the firm.

The company had a debt level of 927.7 million and retained earnings of 806.60 in the year 2019. As a result, Darden should adopt the best model of self-fuelled growth, in which the firm should utilize its retained earnings to foster growth and run its operations. The company can also renegotiate its debt from friendly lenders to keep afloat. All these considerations will greatly help in improving the capital base of the organization and render a competitive edge of the company’s rivals.

Reference

Almazari, A. A. (2012). Financial performance analysis of the Jordanian Arab bank by using the DuPont system of financial analysis. International Journal of Economics and Finance, 4(4), 86-94.

Acheampong, P., & Agalega, E. (2013). Examining the Dividend Growth Model for Stock Valuation: Evidence from Selected Stock on the Ghana Stock Exchange. Research Journal of Finance and Accounting, 4(8), 112-120.

Parker, S. C., & Van Praag, C. M. (2006). Schooling, capital constraints, and entrepreneurial performance: The endogenous triangle. Journal of Business & Economic Statistics, 24(4), 416-431.