Question

Balance Sheet Cash                       150,000.00    Accts receivable         200,000.0

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?

A .4361                               

B .9629    E. none of the above

C .0385                               D.           .0370

What is the after tax cost of Debt?

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

B.136                            D.              .092

What is the cost of equity?

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

B .16                              D.              .15

What is the Wacc ?

A .087                            C.    .01227                       E. .6395

B .034                            D.              .0993

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Homework Answers

Answer #1

What is the sustainable growth rate?

Sustainable growth rate (g) = ROE * retention ratio

ROE = Net Income/ Total equity = Net Income/(total assets - total liabilties) = 290,000/(1,040,000-375,000) = 0.4361

Retention ratio = 1 -payout = 1-0.15 = 0.85

g = 0.4361*0.85 = 0.3706

Susbtaiunable growth rate = 0.3706 (Option E: None of the above)

What is the after tax cost of Debt?

The after tax cost = pretax cost *(1-tax rate) = 5%*(1-0.32) = 3.4% =0.034(Option C)

What is the cost of equity?

Cost of equity = rf + beta*(rm -rf)

rf = 1.2%, rm = 7.4%, beat = twice of market = 2*1 = 2

Cost of equity = 1.2+2*(7.4-1.2) = 13.6% = 0.136 (Option E: None of the above)

What is the Wacc ?

Weight of equity = (1,040,000-375,000)/1,040,000 = 0.6394

Weight of debt = 1-0.6394 = 0.3606

Cost of debt = 3.4%, Cost of equity 13.6%

WACC = 0.6394*13.6% +0.3606*3.4% = 9.93% = 0.0993 (Option D)

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