COOGAN INC, 2002 AND 2003 BALANCE SHEETS 5. The stock price is $40 per share and

Question

COOGAN INC, 2002 AND 2003 BALANCE SHEETS

5. The stock price is $40 per share and there are 1000 shares outstanding, compute market value measures: P/E ratio, market/book ratio

6. Use the Du Pont Identity to compute the return on equity.

7. Suppose the firm decides to reduce its total debt ratio to 0.2 by selling new common stock and using the proceeds to repay principal on some outstanding long-term debt. How much equity financing will Coogan have to raise?

SALES 25,000 COST OF GOODS 16,000 DEPRECIATION 3,000 EARNINGS BEFORE INTEREST AND TAXES 6,000 INTEREST PAID 2,000 TAXABLE INCOME 4,000 TAXES (34%) 1,360 NET INCOME 2,640 (ADDITION TO) RETAINED EARNINGS 1,584 DIVIDENDS 1,056

Explanation / Answer

Question 5:

P/E Ratio = Price per Share/Earnings per Share

Earnings per Share = Net Income/Number of Shares outstanding = $2640/1000 =$2.64

P/E Ratio = 40/2.64 = 15.15

Market to Book Ratio = Market Capitalization/Book value

Market Capitalization = Number of Shares * Market Price per share = 1000 * $40 = $40,000

Book Value = (Common Equity + Retained Earnings) = $16,500 + $11,584

Market to Book ratio = ($40,000)/($28,084) = 1.42

Question 6:

According to DuPont Analysis,

ROE = Net Profit Margin * Total Asset Turnover * Equity Multiplier

Net profit margin = Net Income/Sales = 2640/25000 = 10.56%

Total Asset Turnover = Sales/Average Total Assets = 25000/(48000 + 50000)/2 = 0.51

{where Average total assets = (Total Assets in 2002 + Total Assets in 2003)/2}

Equity Multiplier = Average Total Assets/Average Equity = 49000/(24000 + 28084)/2 = 1.88

{where Average total Equity = (Total Equity in 2002 + Total Equity in 2003)/2}

ROE = 10.56% * 0.51 * 1.88 = 10.14%

Question 7:

Total Debt Ratio = Long term debt/(Total Long term Debt + Total Equity)

Total Debt Ratio = 13000/(13000+28084) = 0.316

Company now wants to reduce this ratio to 0.2 by retiring some debt and instead raise equity capital. This implies total capital of company would remain constant. Portion retired from debt would be appraised through common stock.

This means, 0.2 = New Debt/Total capital = New Debt/41084

New Debt = $8,216.8

New Equity Issuance Required = $13000 - $8216.8 = $4,783.2

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