Question #1 – Strategic Quantitative Financial Analysis
Last year Swensen Corp. had sales of $303,225, operating costs of $267,500, and year-end assets of $195,000. The debt-to-total-assets ratio was 27%, the interest rate on the debt was 8.2%, and the firm's tax rate was 37%. The new CFO wants to see how the Return on Equity (ROE) would have been affected if the firm had used a 45% debt ratio. Assume that sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant. By how much would the ROE change in response to the change in the capital structure?
Question #2 – Financial Statement Interpretation
Please take the company you have chosen in Case #1 Question #4 and perform a Financial Analysis using the available data for the most recent fiscal year (i.e. 12/31/19) and compare that year to the previous fiscal year (i.e. 12/31/18).
Your analysis should include at least one analytical equation from each of the five sections of Financial Analysis given in Chapter 3 and detailed on Page 119 of your text.
· Liquidity · Asset Management · Debt Management · Profitability · Market Value
In your analysis should include the following interpretations:
1. Has the firm improved its’ performance from the previous year? 2. Is the firm managed efficiency? 3. As a potential investor would you consider this a stock you would purchase.
Question #3 – Weighted Average Cost of Capital
Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets. They then provide funds to their different divisions for investment in capital projects. The divisions may vary in risk, and the projects within the divisions may also vary in risk. Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects. Calculate the WACC for your firm with the data you calculated in Case #1 Question #4, as part of your explanation, and the debt information below. Interpret your WACC to the statement above. Cost of Equity - Make sure your cost of capital calculation has the following data points: · Firm’s Beta · Risk Free Interest Rate = .735% · Market Risk Return = 7.50%
Cost of Debt – Each company below is listed with average Cost of Debt and the firm’s tax rate. You need to determine their capital structure mix of debt and equity. | Firm | Average Cost of Debt | Tax Rate | HD | 7.25% | 25% | | | | Nike | 8.10% | 20% | | | | Amex | 6.75% | 22% | | | | 3M | 7.00% | 25% | | | | MSFT | 6.10% | 20% | | | | J & J | 8.55% | 22% | | | | Boeing | 9.00% | 30% | | | | Walmart | 5.85% | 25% | | | | Coke | 7.35% | 26%
Answered Same Day
Apr 30, 2021
Solution
Ayush answered on
May 01 2021
Slide 1
Question #1 – Strategic Quantitative Financial Analysis
Given Data:
Financial Items Existing New
Sales $303,225 $303,225
Operating Costs $267,500 $267,500
Year-end Assets $195,000 $195,000
Debt/Total Assets (%) 27% 45%
Interest on debt (%) 8.2% 8.2%
Firm Tax Rate (%) 37% 37%
Assumptions: Sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant
Question #1 – Strategic Quantitative Financial Analysis
In Summary
Income Statement Existing New
Sales $303,225 $303,225
Operating Costs $267,500 $267,500
Earning before Interest Taxes (EBIT) (Sales-OC) $35725 $35725
Interest Expense (Interest Rate*Debt) $4317.3 $7195.5
Tax Expense (Tax rate*(EBIT-Interest Exp) $11620.85 $10555.9
Net Income $19786.85 $17973.6
RoE% (NI/Equity) 13.9% 16.7%
Changing capital structure from 27% to 45% will lead to a change of +2.8% of ROE
As we can see, changing debt (increasing) has the benefit of “Tax Shield” (Tax rate*Interest Rate*Debt). However, there is an optimal value of debt that has Tax savings beyond which begin to profitability of the firm deteriorate.
Also, that the higher debt, the greater Return on Equity
For Detailed calculations, Please see next slide.
2
Question #1 – Strategic Quantitative Financial Analysis
Calculations:
Total Asset = Debt + Equity
Existing Debt/ Total Asset = 27%
Debt = 27% * Total Asset =>Debt = 27% * 195000
Debt = $ 52,650, Equity = 195000-52650 = $ 142350
Similarly, we calculate, New Debt = $ 87750, New Equity = $107250
Existing Interest Expenses = Interest Rate * Debt = 8.2%* 52650 = $4317.3
=> New Interest Expense = 8.2%* 87750 = $7195.5
Existing Tax Expense = 37%*(EBIT-Interest Exp) = 37%* 31407 = $11620.85
=>New Tax Expense = 37%*(EBIT-Interest Exp) = 37%*28529.5 = $10555.9
Net Income = Sales – OC – Interest Expense – Tax Expense
=>Existing NI = $19786.85
=> New NI = $17973.6
Return on Equity (ROE) =...
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