Compute cost of equity capital for each of three companies

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Reference no: EM131538375

Project Assignment: Case Analyses

1. McMagon Company must raise $100 million on January 1, 2012 to finance its expansion into a new market.  The CFO has come up with three alternatives for raising the money:

1) Issue $100 million of 8% nonconvertible debt due in 20 years.

2) Issue $100 million of 6% nonconvertible preferred stock (face value $25 per share, 4 million shares).

3) Issue $100 million of common stock (1 million shares).

The company's internal forecasts indicate the following 2012 year-end amounts before any option is chosen:  ($ in millions)               

Total debt           $425

Total shareholders' equity           250

Net income for the year               10

The Company has no preferred stock outstanding but currently has 10 million shares of common stock outstanding.  EPS has been declining for the past several years.  Earnings in 2011 were $1 per share, which was down from $1.10 during 2010, and management wants to avoid another decline during 2012.  One of the company's existing loan agreements requires a debt-to-equity ratio to be less than 2. McMagon pays taxes at a 40% rate.

Required:

Assess the impact of each financing alternative on 2012 EPS and the year-end debt to equity ratio, and give an in-depth discussion to support one of the financing alternative.

2. Watson manufactures and sells appliances. Intro develops and manufactures computer technology. Trenton operates general merchandise retail stores. Selected data for these companies appear in the following table (dollar amounts in millions). For each firm, assume that the market value of the debt equals its book value.

($ amounts in millions)

Watson

Intro

Trenton

Total Assets

$13,532

$109,524

$44,106

Interest-Bearing Debt

$ 2,597

$ 33,925

$18,752

Average Pretax Borrowing Cost

6.1%

4.3%

4.9%

Common Equity:




Book Value

$ 3,006

$ 13,465

$13,712

Market Value

$ 2,959

$110,984

$22,521

Income Tax Rate

35.0%

35.0%

35.0%

Market Equity Beta

2.27

0.78

1.2

Required:

a. Assume that the intermediate-term yields on U.S. Treasury securities are 3.5 percent. Assume that the market risk premium is 5.0 percent.

Compute the cost of equity capital for each of the three companies.

b. Compute the weighted average cost of capital for each of the three companies.

c. Address the market equity beta on each of the three company, what is the interpretation of the beta value for each of the company? Address the nature of the industry that each company belongs to.  

3. The following balance sheet and income statement pertain to Goode Corp., using the following assumptions complete a forecasted 2013 income statement:

Assumptions for 2013:

 

Revenue growth rate

45%

 

COGS

70% of sales

 

Operating expenses

18% of sales

 

Interest expense

12% of beginning long-term debt

 

Tax rate

35%

Goode Corp. Consolidated Statement of Income


(Thousands except per share amounts)

2012

 


Net Revenues

$345,871

Cost of Revenue

(226,546)

SG&A

(83,009)

Operating Income

36,316

Interest Expense

(484)

 Income Before Income Taxes

35,832

Income taxes

(12,541)

Net Income

$23,291

 


Goode Corp Consolidated Balance Sheet


(Thousands)

2012

Current Assets


Cash and Equivalents

7,905

Merchandise inventory

6,308

Accounts receivable

6,614

PPE (including intangibles), net

39,458

Total Assets

60,285

 


Liabilities and Stockholders' Equity


Accounts payable

9,643

Long-term debt

13,500

Shareholders' Equity


Common stock and APIC

28,613

Retained earnings

8,529

Total Liabilities and Shareholders' Eq.

60,285

Required:

a. Complete a forecasted 2013 income statement

b. To forecast all items on the balance sheet, the balance sheet may or may not be balanced, how does a financial analysist ensure that the forecasted balance sheet will be balanced?

Reference no: EM131538375

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