In: Finance
Please consider the following data for the Hercules
Company:
Assets: $3 billion
Equity: $2 billion
Sales: $1.5 billion
EBIT: $300 million
Profit (bt) $200 million
Profit (at) $150 million
Payout ratio is: 30%
Number of common stock shares outstanding is: 50 million shares
a) How much interest is Hercules paying on this debt?
b What is Hercules Company’s current ROE & ROI (return on investment
or return on assets)?
c) i) If Hercules were to float (sell) $500 million in bonds and use the proceeds to buy back 12.5 million common shares back, what would be the new ROE & ROI? Hint: What is the implied book/market price for a share of Hercules common stock? (Assume all else remains unchanged).
ii) If Hercules were to float (sell) $500 million in bonds and use the proceeds to buy new plant and equipment that would cause sales to increase to $2.5 billion with an increase in COGS of $800 million, what would be the new ROE & ROI? (Assume the tax rate & the interest 'rate' on debt remains unchanged.)
d)What are the sustainable growth rates for part b), c i) and c ii)?
b) c i) c ii) ____________
Part A)
Amount of interest expense = EBIT – profit before tax
= $300,000,000 - $200,000,000
= $100,000,000
Part B)
ROE = After tax profit / Equity
= 150,000,000/ 2,000,000,000
= 7.50%
ROI = After tax profit / assets
= 150,000,000 / 3,000,000,000
= 5%
Part C) i)
Price per share = 2,000,000,000 / 50,000,000
= $40
Common shares outstanding after restructuring = 50,000,000 -12,500,000
= 37,500,000
Interest rate = Amount of interest/ amount of debt
= 100,000,000 / 1,000,000,000
= 10%
New interest expense = total debt x interest rate
= (1,000,000,000 +500,000,000) x 10%
= 150,000,000
ROE = (EBIT – interest exp) x (1- tax rate)/ Equity
= (300,000,000 – 150,000,000) x (1-25%)/ (37,500,000 x 40)
= 150,000,000 x 0.75/ 1500,000,000
= 7.50%
ROI = Net income/ Assets
= 150,000,000 x0.75 / 3,000,000,000
= 3.75%
Part Cii)
New interest expense = total debt x interest rate
= (1,000,000,000 +500,000,000) x 10%
= 150,000,000
New EBIT = $300,000,000 +2,500,000,000 -800,000,000
= 2,000,000,000
ROE= (EBIT – interest exp) x (1- tax rate)/ Equity
= ( 2,000,000,000 – 150,000,000) x (1-0.25)/ 2,000,000,000
= 69.375%
ROI = Net Income/ assets
= 1387500000/ (3,000,000,000+500,000,000)
= 39.64%