XYZ\'s balance sheet and income statement are given below: Balance Sheet: Cash $

Question

XYZ's balance sheet and income statement are given below: Balance Sheet: Cash $ 50 Accounts payable $ 100 A/R 150 Notes payable 0 Inventories 300 Long-term debt (10%) 700 Fixed assets 500 Common equity (20 shares) 200 Total assets $1,000 Total liabilities and equity $1,000 Income Statement: Sales $1,000 Cost of goods sold 855 EBIT $ 145 Interest 70 EBT $ 75 Taxes (33.333%) 25 Net income $ 50 The industry average inventory turnover is 5, the interest rate on the firm's long-term debt is 10%, 20 shares are outstanding, and the stock's P/E is 8.0. If XYZ increased its inventory turnover to the industry average, if it used freed-up funds to buy back common stock at the current market price and thus to reduce common equity, and if sales, the cost of goods sold, and the P/E ratio remained constant, by what dollar amount would its stock price increase?

$ 3.33

$ 6.67

$ 8.75

$10.00

$12.50

Explanation / Answer

XYZ All Amounts in $ Inventory Turnover Ratio = Cost of Goods Sold / Inventory = 855/300 = 2.85 If the Inventory Turnover Ratio is increased to 5, there will an amount of $ 129 released from inventory ($ 300 - $ 171 which is 5 times the Cost of Goods Sold) From the Current P/E ratio of 8, the Price per share which is currently running in the market works out to 50 X 8 / 20 = $ 20. Thus, if the amount released is used to buy back shares at the existing market price, the number of shares (rounded off) which will be bought back is 6.45 or 6.5 shares. The number of shares thus goes down from 20 to 13.5 shares With this number, assuming the Net Income as constant and the P/E Ratio also same, The Earning per share will be $ 50 / 13.5 = 3.704 $ per share Hence, the Price per share will be 3.704 X 8 = 29.63 $ Thus, the dollar amount by which the stock price would increase is 9.63 $ Since $ 10.00 is the closest to this amount, this can be considered to be the correct solution. Alternatively, going by the reducing balance method, $ 8.75 can also be considered as an option.

Related Questions

Navigate

• Browse (All)
• Browse X
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.