A company has just been taken over by new management that believes it can raise

# A company has just been taken over by new management

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40.A company has just been taken over by new management that believes it can raise earnings before taxes (EBT) from \$897 to \$1,200, merely by cutting overtime pay and reducing cost of goods sold. Prior to the change, the following data applied:DataAmountTotal assets\$10,000 Debt ratio45%Tax rate35%BEP ratio15%EBT\$897 Sales\$16,000 These data have been constant for several years, all income is paid out as dividends, and you may assume that sales, the tax rate, and the balance sheet will remain constant. Based on this information, determine the firm’s currentcost of debt.*BEP = 15% = EBIT / Assets EBIT = (.15)(\$10,000) = \$1,500Interest = EBIT - EBT = \$1,500 - \$897 = \$603Debt = (\$10,000)(.45) = \$4,500Interest Rate = \$603 / \$4,500 = 13.4%YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 41:Income StatementYear: 2004Year: 2003Sales\$15,000.00\$13,500.00Operating costs (excluding depreciation and amortization)\$12,000.00\$10,800.00EBITDA\$3,000.00\$2,700.00Depreciation\$750.00\$675.00Old Exam Questions - Financial Statements, Cash Flow, and Taxes - SolutionsPage 40 of 72 Pages
Earnings before interest and taxes\$2,250.00\$2,025.00Interest \$250.00\$185.00Earnings before taxes\$2,000.00\$1,840.00Taxes (35%)\$700.00\$644.00Net income available to common stockholders\$1,300.00\$1,196.00Common dividends\$315.00\$289.80Balance SheetYear: 2004Year: 2003Assets:Cash and marketable securities\$1,500.00\$1,350.00Accounts receivable\$4,500.00\$4,050.00Inventories\$6,000.00\$5,400.00Total current assets\$12,000.00\$10,800.00Net plant and equipment\$7,500.00\$6,750.00Total assets\$19,500.00\$17,550.00Liabilities and equity:Accounts payable \$3,000.00\$2,700.00Notes payable\$1,000.00\$350.00Accruals\$2,015.00\$2,000.00Total current liabilities\$6,015.00\$5,050.00Long-term bonds\$1,500.00\$1,500.00Total debt\$7,515.00\$6,550.00Common stock (50 million shares)\$10,000.00\$10,000.00Retained earnings\$1,985.00\$1,000.00Total common equity\$11,985.00\$11,000.00Total liabilities and equity\$19,500.00\$17,550.0041.Determine your company's free cash flow for 2004.*NOWC2003= Current assets - Non-interest charging current liabilities= \$10,800 - \$4,700 = \$6,100NOWC2004= Current assets - Non-interest charging current liabilities= \$12,000 - \$5,015 = \$6,985NOWC = \$6,985 - \$6,100 = \$885NFA2003= \$6,750Old Exam Questions - Financial Statements, Cash Flow, and Taxes - SolutionsPage 41 of 72 Pages
NFA2004= \$7,500NFA = \$7,500 - \$6,750 = \$750GFA = NFA + DEP = \$750 + \$750 = \$1,500NOPAT2004= (\$2,250)(1-.35) = \$1,462.50OCF2004= NOPAT2004+ DEP = \$1,462.5 + \$750 = \$2,212.50FCF2004 = NOPAT2004- NOWC - NFA = \$1,462.50 - \$885 - \$750 = -\$172.50FCF2004 = OCF2004- NOWC - GFA = \$2,212.50 - \$885 - \$1,500 = -\$172.50Proof:FCF-\$172.50Interest-\$250.00Tax Shelter+\$ 87.50 Dividends-\$315.00Notes Payable+\$650.00Total\$ 0.0042.Assume that your firm plans to take on a project that will have an infinite life and produce the free cash flows listed below. Also assume that the \$10,000 invested in Year 0 was supplied by investors as \$5,000 of debt, at a before-tax cost of debt of 5 percent, and \$5,000 of equity, at a cost of equity of 12 percent. Finally, you may assume that the firm’s tax rate is 40 percent. Given this data, determine the net present value of this project.YearOCF∆NOWC∆GFAFCF0\$0-\$4,000-\$6,000-\$10,0001\$1,200\$0\$0\$1,2002\$1,200\$0\$0\$1,2003\$1,200\$0\$0\$1,200\$1,200\$0\$0\$1,200\$1,200\$0\$0\$1,200\$1,200\$0\$0\$1,200*WACC = (.05)(1-.4)(.5) + (.12)(.5) = .015 + .06 = .075 = 7.5%Old Exam Questions - Financial Statements, Cash Flow, and Taxes - SolutionsPage 42 of 72 Pages
Enterprise Value = \$1,200 / .075 = \$16,000Increase in Value = NPV = \$16,000 - \$10,000 = \$6,000Alternatively:EVA = \$1,200 - (\$10,000)(.75) = \$450NPV = \$450 / .075 = \$6,000YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 43 -44:Income Statement (In Thousands)Year: 2005Year: 2004Sales\$18,000.00\$15,000.00Operating costs (excluding depreciation and amortization)\$14,400.00\$12,000.00