PLEASE USE ONE OF THE FOUR COMPANIES LISTED BELOW:EXXON MOBILEYAHOOWALMARTMCDONALDS1. Select ONE
of the four companies provided by your professor for analysis.
2. Complete the Financial Analysis Exercise IV Worksheet.
From the http://thatswacc.com/ results for your company: Part A
WACC - ______________
Cost of debt, rD - _____________________
Corporate tax rate, TC - __________________
Percentage of Financing from Debt. D / V - _____________________
Cost of equity, re - ____________________
Percentage of Financing from Equity, E / V - ________________________
Part B: Dividend Payout and Growth Ratios
Recall from Module 1 the following two ratios:
Internal growth rate = (ROA ∙ RR) / [1-(ROA ∙ RR)] (Eq. 3-32)
RR = Retention ratio
= Addition to retained earnings / Net income available to common stockholders (Eq. 3-33)
- The internal growth rate measures the amount of growth a firm can sustain if it uses only internal financing (retained earnings) to increase assets
Sustainable growth rate = (ROE ∙ RR) / [1-(ROE ∙ RR)] (Eq. 3-35)
- If the firm uses retained earnings to support asset growth, the firm's capital structure will change, i.e., the share of equity will increase relative to debt
- To maintain the same capital structure managers must use both debt and equity financing to support asset growth
- The sustainable growth rate measures the amount of growth a firm can achieve using internal equity and maintaining a constant debt ratio
1. For the firm selected for Part A, calculate its internal growth rate for the last fiscal year:
= (ROA ∙ RR) / [1-(ROA ∙ RR)]
2. Calculate the firm's sustainable growth rate for the last fiscal year:
= (ROE ∙ RR) / [1-(ROE ∙ RR)]
Note: Should the http://thatswacc.com/ not be available you can still respond to the questions below in terms of the effects on WACC of changes in the overall and relative levels of debt and/or equity in the financing of your chosen firm.
1. Consider your results for Parts A and B. If the chosen firm grows at its internal growth rate, increasing assets only with its retained earnings, how will this likely affect its WACC?
2. If the chosen firm grows at its sustainable growth rate with increases in both its retained earnings and debt, maintaining a constant debt ratio, how will this affect its WACC?
3. If the chosen firm attempts to grow faster than its sustainable growth rate with modest increases in its debt ratio, how will this likely affect its WACC? What about very large increases in its debt ratio? Explain.
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