B&B is a firm in the furniture industry. Its revenues will be $10m, its costs (n
ID: 2635847 • Letter: B
Question
B&B is a firm in the furniture industry. Its revenues will be $10m, its costs (not including
depreciation) will be $2m, depreciation will be $2m, and capital expenditures will be
$2m. All of these figures (including Capex) accrue at the end of this year. Moreover,
these figures are expected to remain constant each year for the foreseeable future. The
firm has a 20% debt-to-value ratio and pays 8% on its debt. B&B plans to maintain this
ratio of debt-to-value forever. The firm has 1m shares outstanding.
You have no further information about B&B. However, you have the following
information about ABC, a firm that is also in the furniture industry:
Explanation / Answer
let us assume that since both the firms are in the same industry, the value of debt is equal for both.
Debt for B&B = $200,000,000
Debt to value ratio is 20% for B&B
Debt to value ratio = Total debt / Total value
20% = $200,000,000 / Total value
Total value = $1000,000,000
Net income for B&B is
Net income = Sales - Costs - Depreciation - Interest expense - Tax expense
= $10 m - $2m - $2 m - 8% ($200 m ) - 50%
= $6 m - $16m - 50%
= -$5,000,000
Therefore, the net loss is -$5 m
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Return on assets = Net income / Total assets
= -$5,000,000 / $1,000,000,000
= -0.5%
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b) share price for B&B is Total value divided by number of shares outstanding.
Share price = $1,000,000,000 / 1,000,000
= $1,000
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