Question

In: Accounting

2009 2010 Sales ($ millions) 1000 1112 Cost of Goods Sold ($ millions) 500 556 Other...

2009

2010

Sales ($ millions)

1000

1112

Cost of Goods Sold ($ millions)

500

556

Other Expenses ($ millions)

100

111

Depreciation ($ millions)

100

Interest Expense ($ millions)

50

55

Total Current Assets ($ millions)

600

700

Total Fixed Assets ($ millions)

2200

2500

Accumulated Depreciation ($ millions)

400

This can be determined from the information given

Net Fixed Assets ($ millions)

1800

2000

Total Current Liabilities ($ millions)

450

550

Long-term Liabilities ($ millions)

900

975

Common Stock ($ millions)

500

This can be determined from the information given

• The firm’s plowback ratio (this ratio is also called the retention ratio and the reinvestment rate) is 60%

• The firm’s tax rate is 40%

• The required return on the company’s stock is 10%

1. Construct the firm’s income statements and balance sheets for 2009 and 2010.

2. Calculate the firm’s cash flows (OCF, NCS, change in NWC, CFC, CFS, and FCF) for 2010. Assume all values are year-end values.

3. Calculate the company’s internal growth rate (IGR) and sustainable growth rate (SGR).

4. Use the SGR to forecast three years of financial statements. List all assumptions made to create the forecasts. Use long-term debt as the plug.

5. Use the internal growth rate (IGR) as a permanent growth rate in dividends and estimate the stock price using the single-stage dividend growth model. Use the financial data to find the current dividend per share. There are 3 million shares outstanding. What does the dividend growth model predict the stock price to be? How does the required return break down into its income (DY) and price (CGY) components?

6. If the actual stock price is $50, which of the following might be a valid reason for the large discrepancy between the predicted stock price from above and the actual stock price of $35?

a. The market expects the company to grow at a faster rate than the internal growth rate.

b. The market expects the company to grow at a slower rate than the internal growth rate.

c. The market requires a higher return than the 10% you used to find the stock price?

d. The company is doing very poorly.

e. The company is doing very well.

Expert Solution

1) Firm’s Income Statement for the Year 2009 and 2010

2) Calculation the firm’s cash flows (OCF, NCS, change in NWC, CFC, CFS, and FCF) for 2010. Assume all values are year-end values.

3) Company’s Internal Growth Rate and Sustainable Growth Rate

Internal Growth Rate = Return on Assets*Retention Ratio/ 1-(= Return on Assets*Retention Ratio)

For Year 2010= 10.74*60%/1-(10.74*60%) = 1.18

For Year 2009= 10.42*60%/1-(10.42*60%) = 1.19

Sustainable Growth Rate = Return on Equity*Retention Ratio

For Year 2010= 25.06*60%= 15.04%

For Year 2009= 25.42*60%= 15.25%

Workings:-

Return on Assets= Operating Income/ Total Assets

For Year 2010= 290/2700 = 10.74%

For Year 2009= 250/2400 = 10.42%

Retention Ratio = Retained Earnings/ Net Income

For Year 2010= 104.40/174 = 60%

For Year 2009= 90/150 = 60%

Return on Equity= Net Income/ Shareholder’s Equity

For Year 2010= 174/694.40= 25.06%

For Year 2009= 150/590= 25.42%

6) If the actual stock price is $50, which of the following might be a valid reason for the large discrepancy between the predicted stock price from above and the actual stock price of $35?

Answer: a.) The market expects the company to grow at a faster rate than the internal growth rate.

ekkarill92 answered 1 year ago

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