Requesting assistance with Part C of the assignment, as well as how to caluclate
ID: 2710588 • Letter: R
Question
Requesting assistance with Part C of the assignment, as well as how to caluclate and solve the total debt for the firm balance sheet. Thank you.
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
The Coca-Cola Company
Ticker Symbol
KO
From the http://thatswacc.com/ results for your company:
WACC
8.23%
Cost of debt, iD
1.23%
Corporate tax rate, TC
23.84%
Total debt, D
39,412,000.00
Total equity, E
182,480,000.00
Total firm value, V
221,892,000.000
Cost of equity, iE
9.80%
CAPM Components
Beta,
0.85
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
0.8224
Weighted Average Cost of Equity
E
9.8%
Weight of Debt
0.1776
Pre-Tax Weighted Average Cost of Debt
D
1.23%
After-Tax Weighted Cost of Debt
D · (1- TC)
0.9368%
Weighted Average Cost of Capital
= · iE + · iD · (1-Tc)
8.23%
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:
ROE = 3.90% ROA=3.21% Net Income for December 2014 = 7,124,000
= (ROA RR) / [1-(ROA RR)]
0.0321 x 0.60 / 1-(0.0321 x 0.60 = 0.01926/1-0.01926
= 1.96%
2. Calculate the firm’s sustainable growth rate for the last fiscal year:
= (ROE RR) / [1-(ROE RR)]
0.039 x 0.60 / 1-(0.039 x 0.60) = 0.0234/1-0.0234
= 2.4%
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 wills 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.
Appendix
Should the Web site http://thatswacc.com/ not be available, please follow the instructions below that have been posted at http://thatswacc.com/faccs.php on how to calculate the terms in WACC.
The components of the WACC equation are calculated using the following financial data:
From the firm’s balance sheets:
Period ending
Last Fiscal Year
Last Fiscal Year -1
Last Fiscal Year -2
Short term debt + Current portion of long term debt (CMLTD)
22,682,000
17,925,000
17,874,000
Long Term Debt
19,063,000
19,154,000
14,736,000
Total debt, D
From the from the firm’s income statements:
Period ending
Last Fiscal Year
Last Fiscal Year -1
Last Fiscal Year -2
Interest expense
483,000
463,000
397,000
Income before tax
9,325,000
11,477,000
11,809,000
Income tax
2,201,000
2,851,000
2,723,000
Other data:
Firm’s current market capitalization (intraday stock price shares outstanding)
182.48B
Firm’s beta,
0.85
Return on the market, iM
Assume 11%
Risk-free rate, iF
Assume 3%
The calculations in the table are based on the following:
Total debt, D, is the sum of Short term debt + CMLTD + Long Term Debt
Total equity, E, is the firm’s current market capitalization = current stock price times the number of shares outstanding. [Should http://thatswacc.com/ not be available, Market capitalization is available on the “Summary” page at the Yahoo Finance (http://finance.yahoo.com/) site for the stock.]
Total value of the firm, V, equals Total debt, D, + Total equity, E
Cost of debt, iD, = Interest pd in most recent fiscal yr/(Sum of total debt in last two fiscal yrs/2)
iD = Interest expense/Average debt
[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.
Name of Company/Stock
The Coca-Cola Company
Ticker Symbol
KO
Explanation / Answer
Part C a.
As per use more and more retained earnings to finance assets the WACC will tend to cost of equity capital as weight to debt will decline gradually
where WACC = wd(rd)(1 – T) + wc(rs)
b) if constant debt ratio is maintained wacc will remain the same
c) if debt ratio is increased slightly weight to cost of debt capital increase and WACC decreases , however with greater allocation to debt the cost of debt capital and equity capital increases due to greater default risk causing overall WACC to start shooting up at extremely higher debt ratios
total debt
Total debt, D, is the sum of Short term debt + CMLTD + Long Term Debt
Weight of Equity 0.822 0.85 0.9 0.95 1 Weight of DEBT 0.1776 0.15 0.1 0.05 0 Cost of equity 9.80% 9.80% 9.80% 9.80% 9.80% Cost of debt 1.23% 1.23% 1.23% 1.23% 1.23% Tax rate 23.84% 23.84% 23.84% 23.84% 23.84% WACC= 8.23% 8.47% 8.91% 9.36% 9.80%Related Questions
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