Optional project: Case Analyses

McMagon Company must raise $100 million on January 1, 2012 to finance its expansion into a new market. The CFO has come up with three alternatives for raising the money:

1) Issue $100 million of 8% nonconvertible debt due in 20 years.

2) Issue $100 million of 6% nonconvertible preferred stock (face value $25 per share, 4 million shares).

3) Issue $100 million of common stock (1 million shares).

The company’s internal forecasts indicate the following 2012 year-end amounts before any option is chosen: ($ in millions)

Total debt           $425

Total shareholders’ equity           250

Net income for the year               10

The Company has no preferred stock outstanding but currently has 10 million shares of common stock outstanding. EPS has been declining for the past several years. Earnings in 2011 were $1 per share, which was down from $1.10 during 2010, and management wants to avoid another decline during 2012. One of the company’s existing loan agreements requires a debt-to-equity ratio to be less than 2. McMagon pays taxes at a 40% rate.

 

Required:

Assess the impact of each financing alternative on 2012 EPS and the year-end debt to equity ratio, and give an in-depth discussion to support one of the financing alternative.

  1. Watson manufactures and sells appliances. Intro develops and manufactures computer technology. Trenton operates general merchandise retail stores. Selected data for these companies appear in the following table (dollar amounts in millions). For each firm, assume that the market value of the debt equals its book value.
($ amounts in millions) Watson Intro Trenton
Total Assets $13,532 $109,524 $44,106

 

Interest-Bearing Debt $ 2,597 $ 33,925 $18,752
Average Pretax Borrowing Cost 6.1% 4.3% 4.9%
Common Equity:      
     Book Value $ 3,006 $ 13,465 $13,712
     Market Value $ 2,959 $110,984 $22,521
Income Tax Rate 35.0% 35.0% 35.0%
Market Equity Beta 2.27 0.78 1.2

 

Required:

  1. Assume that the intermediate-term yields on U.S. Treasury securities are 3.5 percent. Assume that the market risk premium is 5.0 percent.

Compute the cost of equity capital for each of the three companies.

 

  1. Compute the weighted average cost of capital for each of the three companies.

 

 

  1. Address the market equity beta on each of the three company, what is the interpretation of the beta value for each of the company? Address the nature of the industry that each company belongs to.

 

 

 

  1. The following balance sheet and income statement pertain to Goode Corp., using the following assumptions complete a forecasted 2013 income statement:

 

Assumptions for 2013:
  Revenue growth rate 45%
  COGS 70% of sales
  Operating expenses 18% of sales
  Interest expense 12% of beginning long-term debt
  Tax rate 35%

 

Goode Corp. Consolidated Statement of Income  
(Thousands except per share amounts) 2012
   
Net Revenues $345,871
Cost of Revenue (226,546)
SG&A (83,009)
Operating Income 36,316
Interest Expense (484)
Income Before Income Taxes 35,832
Income taxes (12,541)
Net Income $23,291
   
   
Goode Corp Consolidated Balance Sheet  
(Thousands) 2012
Current Assets  
Cash and Equivalents 7,905
Merchandise inventory 6,308
Accounts receivable 6,614
PPE (including intangibles), net 39,458
Total Assets 60,285
   
Liabilities and Stockholders’ Equity  
Accounts payable 9,643
Long-term debt 13,500
Shareholders’ Equity  
Common stock and APIC 28,613
Retained earnings 8,529
Total Liabilities and Shareholders’ Eq. 60,285

 

Required:

  1. Complete a forecasted 2013 income statement
  2. To forecast all items on the balance sheet, the balance sheet may or may not be balanced, how does a financial analysist ensure that the forecasted balance sheet will be balanced?
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