Balance Sheet Cash 15000000 Accts receivable 20000000 Invent

Balance Sheet

Cash                       150,000.00   

Accts receivable         200,000.00

Inventory                    220,000.00                                          

Total Liabilities        375,000.00

Fixed Assets                 490,000.00

Total Assets               1,040,000.00

Net Income 290,000.00

Payout ratio    15%

Cash flow     362,000.00

Company can borrow at 5%

The company’s tax rate is 32%

The t-bill rate is 1.2%

Market risk rate is 7.4%

The company has twice the volatility of the overall market.

What is the sustainable growth rate?

.4361                               

B .9629    E. none of the above

.0385                               D.           .0370

What is the after tax cost of Debt?

.043                           C.           .034                            E. none of the above

.136                            D.              .092

What is the cost of equity?

.124                            C. .148                            E. none of the above

.16                              D.              .15

What is the Wacc ?

.087                            C.    .01227                       E. .6395

.034                            D.              .0993

Solution

Total Assets = $ 1040000, Total Liablities = $ 375000, Shareholder\'s Equity = 1040000 - 375000 = $ 665000

Net Income = $ 290000

ROE (Return on Equity) = 290000 / 665000 = 0.4361

Payout Ratio = 15 %

Retention Ratio = 1 - Payout Ratio = 1 - 0.15 = 0.85

Sustainable Growth Rate = ROE x Retention Ratio = 0.4361 x 0.85 = 0.37

Hence, the correct option is (E)

NOTE: There appears to be misrepresentation in decimal points and the answer could be 0.037 which is option (D).

Company Borrowing Cost = 5 % and Tax Rate = 32 %

After-Tax Cost of Debt = (1-0.32) x 5 = 3.4 %

Hence, the correct option is (C).

T-Bill Rate = Risk-Free Rate = 1.2 %, Market Risk Rate = 7.4 %

As the firm\'s return is twice as volatile as the market, the firm\'s beta should be 2.

Cost of Equity = Risk-Free Rate + Beta x (Market Risk Rate) = 1.2 + 2 x (7.4 -1.2) = 13.6 %

Hence, the correct option is (E)

Shareholder\'s Equity = $ 665000 and Liabilities = $ 375000

Debt Proportion = 375000 / 1040000 = 0.3606 and Equity Proportion = 0.6394

WACC = 0.6394 x 13.6 + 0.3606 x 3.4 = 9.93 %

Hence, the correct option is (D).