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SAXTON COMPANY Income Statement For the Year Ended December 31, 2009 Sales (all on credit) ……………………………………………………………...

SAXTON COMPANY

Income Statement For the Year Ended December 31, 2009

Sales (all on credit) …………………………………………………………… $ 4,000,000

Cost of Goods Sold…………………………………………………………………3,000,000

Gross Profit………………………………………………………………………….$ 1,000,000

Selling and Administrative Expenses……………………………………. 450,000

Operating Profit ……………………………………………………………………$ 550,000

Interest Expense…………………………………………………………………… 50,000

Extraordinary Loss…………………………………………………………………. 200,000

Earnings Before Taxes……………………………………………………………$ 300,000

Income Taxes (33%)………………………………………………………………. 100,000

Net Income…………………………………………………………………………….$ 200,000

SAXTON COMPANY

Balance Sheet As of December 31, 2009

Assets Cash…………………………………………………………………………… $ 30,000

Accounts Receivable………………………………………………….. 350,000

Marketable Securities ……………………………………………….. 50,000

Inventory……………………………………………………………………. 370,000

Total Current Assets……………………………………………………. $ 800,000

Net Plant and Equipment…………………………………………….. 800,000

Total Assets………………………………………………………………….$ 1,600,000

Liabilities and Stockholders’ Equity

Accounts Payable…………………………………………………………..$ 50,000

Notes Payable……………………………………………………………….. 250,000

Total Current Liabilities…………………………………………………..$ 300,000

Long Term Liabilities………………………………………………………… 300,000

Total Liabilities ………………………………………………………………..$ 600,000

Common Stock…………………………………………………………………. 400,000

Retained Earnings…………………………………………………………….. 600,000

Total Stockholders’ Equity……………………………………………….$ 1,000,000

Total Liabilities and Stockholders’ Equity………………………… $ 1,600,000

Based upon the Saxton Company (financials), assume that Net Income is a Perpetuity. Then for the Saxton Company:

1. Using Net Income as a Perpetuity, determine a (Present) Value for the Saxton Company assuming that ROE is the % Discount Rate (i.e. % Required Rate of Return)

2. Determine the Weighted Average Cost of Capital (WACC), where ROE can be viewed as the Cost of Equity (component) and the Cost of Debt can be determined by dividing the Interest Expense by the Total Debt

3. Using Net Income as a Perpetuity, determine a (Present) Value for the Saxton Company (now) assuming that the WACC is the Discount Rate (i.e.% Required Rate of Return).

Solutions

Expert Solution

1. Net Income = 200000

Considering Return of Equity (ROE) as discounted rate for finding the value of Saxton company

Return of Equity = Net Income / Total Shareholder's Equity = 200000 / 1000000 = 20%

Using Net Income as perpetuity,

Value of Saxton company = Net Income / Discount rate = Net Income / Return of Equity

= 200000 / 20% = $1000000

2. Total Debt = D = Long term liabilities + Notes payable = 300000 + 250000 = 550000

Total shareholder's equity = E = 1000000

Cost of Debt = Rd = Interest Expense / Total Debt = 50000 / 550000 = 9.09%

Cost of Equity = Re = Return of equity = 20%

WACC = 35.48% x 9.09% 67% + 64.52% x 20% = 2.16% + 12.90% = 15.06%

3. Using Net Income as perpetuity and WACC as discount rate,

Value of Saxton Company = Net Income / WACC = 200000 / 15.06% = $1328021.25

jeff jeffy answered 1 year ago
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