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MGFD10H3 Lecture Notes - Lecture 6: Net Present Value

140 views2 pages
greenzebra384
17 Dec 2014
School
UTSC
Department
Finance
Course
MGFD10H3
Professor
Derek Chau

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Document Summary

Given e1 = , d1 = , b = 0. 4, k = 0. 15, and g = 0. 08. [in this example, we assume the constant growth model, that means the firm has constant growth opportunities in every year. ] Value of the firm if no growth = Then npvgo = . 86 . 33 = . 52. At the end of year 1, the firm reinvests 40% () of its earnings and this investment will generate a profit of sh. 4 (*0. 2) per year in years 2, 3, 4, . ( since roe = 20%). Therefore, the total earnings = . 4 in year 2. As the firm keeps the same payout ratio, it reinvests . 16 (. 4*0. 4) in year 2. This second go will generate earnings of sh. 432 (. 16*0. 2) per year forever. *d2 = . 4 . 16 = . 24 (= *1. 08) So the total earnings in year 3 = . 832, reinvests . 3328 (. 832*0. 4) and earns. *d3 = . 832 . 3328 = . 4992 (=*1. 08*1. 08)

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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.

1) The principal amount of a bond that is repaid at the end of the loan term is called _________.

2) _________ plots the yields on bonds relative to maturity.

3) A _________ is an unsecured bond, for which no specific pledge of property is made

4) An unexpected decrease in market interest rates will cause a coupon bond's yield to maturity to ___________.

5) The yield to maturity on a premium bond ____________ the bond's coupon rate.

6) Assume a constant dividend growth. The _________ of a stock equals its capital gains yield.

7) If a firm pays a constant annual dividend, then the capital gains yield is equal to ____.

8) According to the dividend growth model, the required rate of return is equal to the capital gains yield if the dividend growth rate is ______.

9) Assume a constant dividend growth. A decrease in the capital gains yield will ______ the current value of a stock.

10) _______________ can be used to value the stock of firms that pay no dividends.

11) The reward for bearing risk is called the ___________.

12) The higher the risk, the _____ the return.

13) The geometric average return is _____ than the arithmetic average return for a given set of returns.

14) A group of assets held together by an investor is referred to as a __________.

15) Unsystematic risk can also be referred to as asset-specific risk, ________ risk, idiosyncratic risk, or unique risk.

16) ________ refers to the practice of investing in a variety of diverse assets as a means of reducing risk.

17) An unexpected increase in the variable costs for a firm is an example of _____________ risk.

18) An unexpected decrease in corporate tax rates is an example of __________ risk.

19) If a risky security has more risk than the overall market, its beta coefficient is _______ 1.

20) All else constant, an increase in the market value of preferred stock will affect a firm's weighted average cost of capital by changing the ______ of preferred stock.