Use the following information to answer parts A-D: Assets: Cash 150,000, Assets

Question

Use the following information to answer parts A-D:

Assets: Cash 150,000, Assets receivable 200,000, Inventory 220,000, Fixed assets 490,000, Total assets 1,040,000.

Total Liabilities 375,000

Net Income 290,000, Plowback Ratio 15%, Cash Flow 362,000, Company can borrow at 5%, Tax rate 32%, T-bill rate 1.2%, Market risk rate 7.4%, and the company has twice the volatity of the overall market.

A) What is the sustainable growth rate?

B) What is the after tax cost of debt?

C) What is the cost of Equity?

D) What is Weighted Average Cost of Capital?

Explanation / Answer

a) Sustainable growth rate, g = ROE x plowback ratio

ROE = Net Income / Equity = 290,000 / (1,040,000 - 375,000) = 43.6%

g = 43.6% x 15% = 6.54%

b) After-tax cost of debt, Rd = Cost of debt x (1 - tax rate) = 5% x (1 - 32%) = 3.4%

c) Cost of equity, Re = Rf + beta x (Rm - Rf) = 1.2% + 2 x (7.4% - 1.2%) = 13.6%

d) WACC = wd x Rd + we x Re

here, wd = Debt / Total Assets = 375,000 / 1,040,000 = 36%, we = Equity / Total Assets = 1 - 36% = 64%

=> WACC = 36% x 3.4% + 64% x 13.6% = 9.92%

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