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All questions below analyze the same company. The information below will be needed to answer all...

All questions below analyze the same company. The information below will be needed to answer all questions. Consider the following information regarding ABC Corporation.

2009

2010

Sales ($ millions)

1000

1112

Cost of Goods Sold ($ millions)

500

556

Other Expenses ($ millions)

100

111

Depreciation ($ millions)

100

Interest Expense ($ millions)

Total Current Assets ($ millions)

600

700

Net Fixed Assets ($ millions)

1800

2000

Total Current Liabilities ($ millions)

450

550

Long-term Liabilities ($ millions)

900

975

• The firm’s plowback ratio is 60%

• The firm’s tax rate is 40%

• The company has 30 million shares outstanding. The current stock price is $35.

• The company has two bond issues outstanding. The first issue is 100,000 bonds that have YTM of 5%, coupon rate of 7%, face value of $1000, and mature in 7 years. The second issue is 500,000 bonds with YTM of 8%, face value of $1500, and mature in 13 years. These bonds are currently selling for $1200.

• The expected return on the market is 11%. The risk-free rate is 4%.

• ABC’s beta is 2.15

1. Use market values to find the percentage of the company that is debt-based (Wd).

2. Use market values to find the percentage of the company that is equity-based (We).

3. Use CAPM to find the cost of equity (Re).

4. Find a market-value based weighted average of the bonds’ YTMs (Rd).

5. Use the answers to #1-#4 to find the company’s WACC.

6. Find the company’s internal growth rate (IGR).

7. Use the IGR from #6 and the required return on the stock from #3. Use the financial data to find the current dividend. What does the dividend growth model predict the stock price to be?

8. Which of the following might be a valid reason for the large discrepancy between the predicted stock price from #7 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 one you have using CAPM?

d. The company is doing very poorly.

e. The company is doing very well.

9. Find the firm’s 2010 total cash flow.

10. Find the firm’s 2010 cash flow to shareholders.

Solutions

Expert Solution

You have asked 10 questions in a single post. I am addressing the first four of them. Please post the balance questions separately.

All financials are in $.

1. Use market values to find the percentage of the company that is debt-based (Wd).

Market value of bonds, D = Price per bond x no. of bonds = 1,200 x (100,000 + 500,000) = 720,000,000

Market value of equity, E = Price per share x nos. of shares outstanding = 35 x 30 mn = 1,050,000,000

%age of the company that is debt based = Wd = D / (D + E) = 720 / (720 + 1,050) = 40.68%

2. Use market values to find the percentage of the company that is equity-based (We).

We = 1 - Wd = 1 - 40.68% = 59.32%

3. Use CAPM to find the cost of equity (Re).

Re = Risk free rate + Beta x (Expected return in the market - risk free rate) = 4% + 2.15 x (11% - 4%) = 19.05%

4. Find a market-value based weighted average of the bonds’ YTMs (Rd).

The first issue

100,000 bonds
YTM of 5%

The second issue is

500,000 bonds
YTM of 8%

These bonds are currently selling for $1200.

Market-value based weighted average of the bonds’ YTMs (Rd) = 100,000 / (100,000 + 500,000) x 5% + 500,000 / (100,000 + 500,000) x 8% = 7.50%

Please post the balance part separately.

jeff jeffy answered 6 months ago

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