Question

The following are selected financial information on firm A and B. You are asked to by methodically calculating the missing information.

You will assume that Cost of Goods Sold (COGS) is 65% of Sales and that the company uses a marginal tax rate of 35%.

FIRM A FIRM B

Revenue $ 3,000 $ 3,000

COGS - -

Gross Profit 1,050 1,050

Operating Expenses (300) (300)

EBIT 750 750

Interest Expense - -

Earnings before Tax(EBT) - -

Income Tax @35% - -

Net Income $ 488 $ 472

Earnings per share - -

Dividend per share - -

Expected Return on Equity - -

Estimated Share Price - -

Market value of Equity - -

Market value of Debt - -

Enterprise Value $ 2,181 $ 2,503

Outstanding Debt $ - $ 300

Shares Outstanding 600 300

Cost of Debt 6% 8%

Beta 1.40 1.70

Expected return on Market 9% 9%

Dividend pay-out ratio 50% 60%

Dividend Growth 2% 2%

Risk Free 3% 3%

Common Equity $ 600 $ 300

Company's debt trading @ n/a 105

Which Firm's Shareholders are wealthier? Explain why!                  

Answer 1

	Firm A	Firm B
Revenue	3000	3000
COGS	3000*65%=1950	3000*65%=1950
Gross Profit	1050	1050
OS	300	300
EBIT	750	750
Interest	-	300*8%=24
Income Tax 35%	750*35%=262	750-24=726*35%=254
EAT	488	472
EPS	488/600=0.81	472/300=1.57
Dividend Per share	488*50%=244 =244/600=.41	472*60%=283.2 283.2/300=0.944
Expected return on Equity	Rf +Beta(RM-Rf) 3+1.4(9-3)=11.40%	3+1.7(9-3) =13.20%
Estimated Share Price	0.41/.114 =3.596 Per Share	0.944/.132=7.152 Per share
Market Value of Equity	3.596*600=2157	7.152*300=2146
Market value of Debt	-	300*105/100=315

Shareholder of Firm B is more Wealthier because:

Expected return on equity of Firm B 13.20%> Firm A 11.40%

Estimate share price of Firm B 7.152 > Firm A 3.596 per share

DPS and EPS is also higher than Firm A