The quarterly investors call is approaching and you were asked to comment on the

Question

The quarterly investors call is approaching and you were asked to comment
on the EPS and projected EPS based on the growth forecast of 10%.
(a) Compute the EPS for the calendar year of 2016
(b) What is the projected EPS with the same assumptions as in Question 1?
You are a bit skeptical of the projected 10% growth in sales and decided to look at a much
less aggressive long-run growth scenario of 3.5% growth in sales.
(c) What is the projected EPS for a 3.5% growth in sales? If the dividend payout ratio
remains the same, how much is paid per share?
As some external nancing will be needed to accommodate any growth, you started looking
into raising debt and/or equity. Since your company would be mostly described as a small-
cap US company, you looked at market data to help you determine your costs of equity and
debt.
(d) Using the information (****below****), what should be the risk
premium for appropriate market for your company? Assume the risk free is given by
1mo Treasury Bills.
(e) Looking at historical stock market data, you determined that your beta is roughly 1.4
with respect to the market benchmark you used above to compute the risk premium.
What should your cost of equity be?
(f) In order to get a little more comfortable with the number computed above, you decided
to look at the cost of equity using the dividend growth corresponding to the 3.5%
growth scenario from (c). What is the cost of equity using this approach?
In order to determine your cost of debt, you decided to look at your long term debt, which
is structured as a single 20yr bond with semi-annual coupons, a coupon rate of 10%, and is
currently trading at 105%.
(g) What is your cost of debt?
(h) What is your after-tax cost of debt?
Your CEO is interested in knowing what is the minimum return the company should generate
to make sure investors are satis ed, but is not sure which number to focus on.
(i) What measure should you propose and how would you explain it to your CEO?
(j) What is the value for the proposed measure?

****The concept of risk premium is the extra return earned for taking risk Treasury bills are considered to be risk free, so the risk premium is the return over and above the risk-free rate For example, the average return of Long-term Corporate bonds since 1926 to 2013 was 6.3% against an average return of 3.5% of U.S. Treasury Bills. This means that the Risk Premium for the Long-term Corporate bonds over this period was 2.8%.****

Income Statement 2015 40% Sales COGS Other expenses Depreciation EBIT Interest Taxable income Taxes (40%) Net income $43,000,000 $30,000,000 $5,000,000 $2,000,000 $6,000,000 $2,000,000 $4,000,000 Taxes Shares Outstanding 1,000,000 $1,600,000 $2,400,000 Dividends Add to RE $600,000 $1,800,000 Balance Sheet, Dec 31, 2015 Assets Liabilities & Owners' Equi Current Assets Current Liabilities Cash $500,000 Accounts Receivable $1,000,000 $2,000,000 $3,500,000 Notes Payable Total CL Long Term Debt Accounts Payable $1,000,000 $3,000,000 $4,000,000 $10,000,000 Inventory Total CA Fixed Assets Net PP&E; Owners' Equity $25,000,000 Common Stock $6,500,000 Retained Earnings S8,000,000 Total Equity 14 500000 Total Assets $28,500,000 Total L & OE $28,500,000

Explanation / Answer

d) Using the information (****below****), what should be the risk

The quarterly investors call is approaching and you were asked to comment on the EPS and projected EPS based on the growth forecast of 10%. (a) Compute the EPS for the calendar year of 2016 (b) What is the projected EPS with the same assumptions as in Question 1? a. EPS 2016 Net Income    = $2,400,000 Outstanding shares = 1000000       = $2400,000/1000000 $8,300,000 $3,320,000 EPS $2 per share $4,980,000 b. on the EPS and projected EPS based on the growth forecast of 10%. Sales $43,000,000+ 10% $47,300,000 Net income $4,980,000 shares oustanding $5

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