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Which firm's shareholders are wealthier? Explain why.The following are selected financial information on Firm A and Firm B. You are asked to complete the table by methodically calculating the missing information.

You will assume that Cost of Goods Sold (COGS) is 65% of Sales and that the company uses a marginal tax rate of 35%.

Firm A Firm B

Revenue $ 3,000 $ 3,000

COGS (Blank) (Blank)

Gross Profit 1,050 1,050

Operating Expenses (300) (300)

EBIT 750 750

Interest Expense (Blank) (Blank)

EBT (Blank) (Blank)

Income Tax @35% (Blank) (Blank)

Net Income $488 $472

Earnings per share (Blank) (Blank)

Dividends per share (Blank) (Blank)

Expected Return on Equity (Blank) (Blank)

Estimated Share Price (Blank) (Blank)

Market Value of Equity (Blank) (Blank)

Market Value of Debt (Blank) (Blank)

Enterprise Value $2,181 $2,503

Outstanding Debt $ - $300

Shares Outstanding 600 300

Cost of Debt 6% 8%

Beta 1.40 1.70

Expected return on Market 9% 9%

Dividend pay-out ratio 50% 60%

Dividend growth 2% 2%

Risk free 3% 3%

Common equity $600 $300

Company’s debt trading @ n/a 105

Which firm's shareholders are wealthier? Explain why.

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Tod Thiel
Tod ThielLv2
28 Sep 2019

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The following are selected financial information on Firm A and Firm B. You are asked to complete the table by methodically calculating the missing information.

You will assume that Cost of Goods Sold (COGS) is 65% of Sales and that the company uses a marginal tax rate of 35%.

​Firm A​Firm B

Revenue​$​ 3,000​$ 3,000

COGS​(Blank)​(Blank)

Gross Profit​1,050​1,050

Operating Expense. (300)​​(300)

EBIT​ 750​750

Interest Expense​(Blank)​(Blank)

EBT. ​(Blank)​(Blank)

Income Tax @35%. (Blank)​(Blank)

Net Income​$488​$472

Earnings per share. (Blank)​(Blank)

Dividends per share.​(Blank)​(Blank)

Expected Return on Equity​(Blank)​(Blank)

Estimated Share Price​(Blank)​(Blank)

Market Value of Equity​(Blank)​(Blank)

Market Value of Debt​(Blank)​(Blank)

Enterprise Value​$2,181​$2,503

Outstanding Debt​$ -​$300

Shares Outstanding. 600​300

Cost of Debt​6%​8%

Beta​ 1.40​1.70

Expected return on Market. 9%​9%

Dividend pay-out ratio​ 50%​60%

Dividend growth. ​2%​2%

Risk free​ 3%​3%

Common equity ​$600​$300

Company’s debt trading @​n/a​105

Directions: You MUST show ALL of your work to receive credit on the problems. There will be significant point reductions if you do not show your work. All calculations should be completed to at least 2 decimal places.

1) What is a firm's weighted-average cost of capital if the stock has a beta of 1.45, Treasury bills yield 5%, and the market portfolio offers an expected return of 14%? In addition to equity, the firm finances 30% of its assets with debt that has a yield to maturity of 9%. The firm is in the 35% marginal tax bracket.

2) Compute the weighted-average cost of capital for a firm with the following sources of funds and corresponding required rates of return: $5 million common stock at 16%, $500,000 preferred stock at 10%, and $3 million debt at 9%. All amounts are listed at market values and the firm's tax rate is 35%.

3) Calculate a firm's required rates of return for both of its equity components: Its common stock sells for $50 per share and will pay a $6 dividend next year which is expected to grow at a constant 5% rate. Its preferred stock sells for $22.50 per share and pays $1.80 in dividends. What accounts for the difference in returns, given that these are both forms of equity?

4) Why can faulty decisions be made when all capital budgeting proposals are evaluated at the firm's current weighted average cost of capital?

5)

Here is some information about Stokenchurch Inc.:

Beta of common stock = 1.2

Treasury bill rate = 4%

Market risk premium = 7.5%

Yield to maturity on long- term debt = 6%

Book value of equity = $ 440 million

Market value of equity = $ 880 million

Long- term debt outstanding = $ 880 million

Corporate tax rate = 35%

What is the company’s WACC?

Use the following information to answer the following questions.

ABC, Inc. Income Statement (in thousands)

December 31, 2014

Sales $200,000

Cost of goods sold 140,000

Gross profit on sales 60,000

Operating expenses 56,000

Operating income (EBIT) 4,000

Interest expense 1,000

Earnings before tax 3,000

Income tax 1,050

Net income available to common stockholders $1,950

Number of shares outstanding 1, 500

Market price per share $22

ABC, Inc. Balance Sheet (in thousands)

December 31, 2014

Assets

Cash $2,000

Accounts receivable 17,800

Inventories 8,700

Total current assets 28,500

Gross fixed assets 70,000

Accumulated depreciation 26,500

Net fixed assets 43,500

Total assets $72,000

Liabilities and Equity

Accounts payable $18,000

Accruals 13,350

Total current liabilities 31,350

Long-term debt 8,250

Total liabilities 39,600

Common stock (par value and paid in capital) 2,000

Retained earnings 30,400

Total stockholders' equity 32,400

Total liabilities and equity $72,000

Industry Key Ratios

Industry Average Ratios

Current ratio 1.1

Quick ratio 0.60

Days Sales Outstanding (DSO) 25 days

Fixed assets turnover 5.8

Total asset turnover 2.95

Liabilities-to-assets ratio 65%

Times-interest-earned 3.2

Net profit margin 1.3%

Return on equity 7.32%

Price/earnings ratio 20.38

Market/book ratio 3.19

Calculate current ratio and acid test ratio for the firm.

Calculate DSO, fixed assets turnover, and total asset turnover for the firm.

Calculate liabilities-to-assets ratio and times-interest-earned ratio for the firm.

Calculate net profit margin and return on equity for the firm.

Evaluate the performance of the firm in the following areas:

Liquidity management

Asset management

Debt management

Profitability management

When you explain the firm

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