Question

In: Finance

You have the following financial statement data for a corporation: Revenue = 10,000,000 Operating income =...

You have the following financial statement data for a corporation: Revenue = 10,000,000

Operating income = 7,500,000 interest = 2,500,000

Net Income = 4,000,000 Current Assets = 10,000,000 Total Assets = 100,000,000 Current Liabilities = 8,000,000 Long-term Debt = 50,000,000

Total Common Equity = 42,000,000

You also have the following information: Total Dividends Paid = 1,000,000 Common shares outstanding = 2,000,000

Current share price = $27

The long-term debt consists of one bond issue that has 6 years remaining until maturity. Each bond has a par value of $1,000 and pays an annual coupon. The current yield-to-maturity on the bond issue is 8%.

The firm is considering a capital budgeting project that will require an initial outlay of $1,000,000 that is expected to produce net cash inflow of $200,000 each year for the next 7 years, at which time the project will end. The project under consideration is considered to be of equal risk as the firm's typical project. The firm has not made a decision as to how it will finance the project, if necessary. If it issues new equity to finance the project, it could sell new common equity at the current market price, while incurring total flotation cost of 5%.

The current risk-free rate of return for the market 2%, and the market risk-premium is estimated to stand at 7.5%. You know nothing about the firm's expected dividend policy, but you do know that the firm's equity Beta is 1.8

Based on the information you have, answer the following questions about the firm (You must show work for each question and answer each question separately in order to earn full credit):

  1. What is the firm's profit margin?
  1. Using the DuPont identity and the information given, show the value of the firm's equity multiplier?
  1. What is the firm's P/E ratio?
  1. What is the firm's current ratio?
  1. What is the best estimate of the firm's capital structure according to book value?
  1. What is the total market value of the firm's equity?
  1. What is the total market value of the firm's debt?
  1. What is the total value of the firm based on market value?
  1. What is the firm's capital structure based on market values?
  1. What is the firm's pre-tax cost of debt?
  1. What is the best estimate for the firm's cost of common equity if using retained earnings as a financing option?
    1. What is the best estimate for the firm's WACC if using retained earnings as common equity financing?
    1. What is the best estimate of the NPV for the proposed capital budgeting project, given the info that you have?
    2. Should the firm accept the project based on NPV analysis? Why or why not?
    • What is the IRR for the proposed project?

Solutions

Expert Solution

a. firm's profit margin = Net income/revenues/sales = 4,000,000/10,000,000 = 0.4 or 40%

b. firm's equity multiplier = Total assets/common equity = 100,000,000/42,000,000 = 2.38

c. firm's P/E ratio = Stock price/earnings per share

Earnings per share = earnings/no. of shares outstanding = 4,000,000/2,000,000 = 2

firm's P/E ratio = 27/2 = 13.5

d. firm's current ratio = current assets/current liabilities = 10,000,000/8,000,000 = 1.25

e.  firm's capital structure according to book value = book value of debt/total capital and book value of equity/total capital

book value of debt = 50,000,000; book value of equity = 42,000,000

Total capital = 50,000,000 + 42,000,000 = 92,000,000

book value weight of debt = 50,000,000/92,000,000 = 0.54 or 54%

book value weight of equity = 42,000,000/92,000,000 = 0.46 or 46%

firm's capital structure according to book value is 54% debt and 46% equity.

f. market value of the firm's equity = no. of shares outstanding*market price per share = 2,000,000*27 = 54,000,000

jeff jeffy answered 4 months ago
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