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FIN 300 Lecture Notes - Lecture 3: Justin Bieber, Accrued Interest, Representation Theory

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sangriacrow463
6 Dec 2017
School
Ryerson University
Department
Finance
Course
FIN 300
Professor
Patricia Mc Graw

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Document Summary

Not all growth is worth the price. It is possible to pay so much for the growth that the firm value declines. Other aspects of growth can leave the firm less. May surpass the firm"s distribution capabilities, quality control or change perceptions of the firm and its brand. Internal growth rate = (net income/beginning assets) x (1 - payout ratio) Sustainable growth rate = (net income/beginning equity) x (1 - payout ratio) Example 18. 3 internal and sustainable growth rates and payout policy. Your firm has million in equity and million in debt and forecasts million in net income for the year. It currently pays dividends equal to 20% of its net income. You are analyzing a potential change in payout policy an increase in dividends to 30% of net income. How would this change affect your internal and sustainable growth rates. Example 18. 3 internal and sustainable growth rates and payout policy: plan.

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Related Questions

Financial Analysis Exercise IV

Part A: Weighted Average Cost of Capital (WACC)

Here again is the formula for WACC. For simplicity the term for preferred stock has been removed:

Go to http://thatswacc.com/[1] and enter the ticker symbol for the stock you selected and click on the tab entitled “Calculate WACC.”

Complete the following tables:

Name of Company/Stock

Walt Disney

Ticker Symbol

DIS

From the http://thatswacc.com/ results for your company:

WACC

13.50%

Cost of debt, iD

0

Corporate tax rate, TC

34.98

Total debt, D

48,768,000

Total equity, E

10,251,618,400

Total firm value, V

10,300,386,400

Cost of equity, iE

13.56%

CAPM Components

Beta, β

1.32

Historical market return, iM

Assumed 11%

Risk-free rate, iF

Assumed 3%

Using data in the table confirm the accuracy of the site’s WACC calculation:

Weight of Equity

Weighted Average Cost of Equity

E

Weight of Debt

Pre-Tax Weighted Average Cost of Debt

D

After-Tax Weighted Cost of Debt

D · (1- TC)

Weighted Average Cost of Capital

= · iE + · iD · (1-Tc)

Part B: Dividend Payout and Growth Ratios

Recall from Module 1 the following two ratios:

Internal growth rate = (ROA ∙ RR) / [1-(ROA ∙ RR)] (Eq. 3-30)

where RR = Retention ratio = (Addition to retained earnings)/Net income (Eq. 3-31)

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. 3-33)

If the firm uses retained earnings to support asset growth, the firm’s capital structure will change over time, 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)]

=

Part C.

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? Show calculations.

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?

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.

[1] The accessibility of this site is assumed. Should it not be accessible, please follow the instructions in the Appendix at the end of this document.

Part A: Weighted Average Cost of Capital (WACC)

1. Go to http://thatswacc.com/[1] and enter the ticker symbol for the stock you selected and click on the tab entitled “Calculate WACC.”

2. Complete the following tables:

Name of Company/Stock The Coca Cola Company
Ticket Symbol KO

From the http://thatswacc.com/ results for your company:

WACC 7.81%
Cost of Debt, iD 1.99%
Corporate Tax Rate, TC 23.98%
Total Debt, D 44,213,000,000
Total Equity, E 201,070,000,000
Total Firm Value, V 244,049,000,000
Cost of Equity, iE 9.16%

CAPM Components

Beta, β 0.77
Historical market return, iM Assume 11%
Risk-free rate, iF Assume 3%

3. Using data in the table confirm the accuracy of the site’s WACC calculation:

Weight of Equity .8197469861
Weighted Average Cost of Equity .0750888239 or 7.51%
Weight of Debt .1802530139
Pre-Tax Weighted Average Cost of Debt .003587035 or .36%
After-Tax Weighted Cost of Debt .0027265178 or .27%
Weighted Average Cost of Capital .0078540019 or 7.78%

Part B: Dividend Payout and Growth Ratios:

Internal growth rate = (ROA ∙ RR) / [1-(ROA ∙ RR)]

where RR = Retention ratio = (Addition to retained earnings)/Net income

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)]

If the firm uses retained earnings to support asset growth, the firm’s capital structure will change over time, 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= 8.16% RR= .22 Net Income for December 2015 = 7,351,000

= (ROA ∙ RR) / [1-(ROA ∙ RR)]

= (.0816 ∙ .22) / [1-(.0816 ∙ .22)]

= .0182801655 or 1.83%

2. Calculate the firm’s sustainable growth rate for the last fiscal year:

ROE= 28.77% RR= .22 Net Income for December 2015 = 7,351,000

= (ROE ∙ RR) / [1-(ROE ∙ RR)]

= (.2877 ∙ .22) / [1-(.2877 ∙ .22)]

= .067570828 or 6.76%

Part C

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? Show calculations.

Hi Everyone, I just need help on Part C question 1. I'm confused about the calculations they are asking for to the show the work needed to answer that question. If someone could explain their calculations for the question, I would really appreciate it!

Above I listed all of my work and calculations that I've done for Part A and Part B.

In 2011 the Keenan Company paid dividends totaling $3,760,000 on net income of $15 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 6%. However, in 2012, earnings are expected to jump to $19.5 million and the firm expects to have profitable investment opportunities of $10.8 million. It is predicted that Keenan will not be able to maintain the 2012 level of earnings growth because the high 2012 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2012, the company will return to its previous 6% growth rate. Keenan's target capital structure is 40% debt and 60% equity.

  1. Calculate Keenan's total dividends for 2012 assuming that it follows each of the following policies: (Write out your answers completely. For example, 25 million should be entered as 25,000,000.)

    1. Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.
      $

    3. It continues the 2011 dividend payout ratio. Round your answer to the nearest cent.
      $

    5. It uses a pure residual dividend policy (40% of the $10.8 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.
      $

    7. Assume that investors expect Keenan to pay total dividends of $6,000,000 in 2012 and to have the dividend grow at 6% after 2012. The stock's total market value is $220 million. What is the company's cost of equity? Round your answer to two decimal places.
      %

    9. What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Round your answer to two decimal places.
      %
    10. It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy. Round your answer to the nearest cent.

      Regular-dividend $
      Extra dividend $