Chapter 6: Discussion Question #4 (p. 223)
4. Why is it usually easier to forecast sales for seasoned firms in contrast with early-stage ventures?
Typically, it is easier to forecast a seasoned firm’s sales to that of an early-stage venture because the seasoned firm will have an operational history. Basing current sales on historical data is easier to do than trying to estimate sales based on little to no historical data to benchmark from. If you are a start-up / early-stage venture and you are tasked with forecasting sales, competitors’ operational histories and past sales data could possibly be used as a helpful reference. However, if you are the first of your kind, it will be especially difficult to predict / forecast sales or financials as there is nothing for you to use as a benchmark guide.
Chapter 6: Pharma BioTech Mini Case (pp. 229-230, Part A only)
Pharma Biotech is interested in developing an initial “big picture” of the size of financing that might be needed to support its rapid growth objectives for 2011 and 2012. A.
Calculate the following financial ratios (as covered in Chapter 5) for Pharma Biotech for 2010: (a) net profit margin, (b) sales-to-total-assets ratio, (c) equity multiplier, and (d) total-debt-to-total-assets. Apply the return on assets and return on equity models. Discuss your observations.
Net Profit Margin (NPM) = Net Income / Net Sales
NPM = 960 / 15,000 (in thousands)
NPM = 6.4%
Sales-to-total-assets (STTA) = Net Sales / Total Assets
STTA = 15,000 / 12,000 (in thousands)
STTA = 1.25
Equity Multiplier (EM) = Total Assets / Total Equity
EM = 12,000 / 12,000
EM = 1
Total-debt-to-total-assets (TDTTA) = (Short-term debt + Long-term debt) / Total Assets TDTTA = (4,600 + 2,200) / 12,000
TDTTA = 6,800 / 12,000
TDTTA = 0.5666 or 0.567
Return on assets model is Net Income / Total Assets and gives us an indication of how profitable a company is in relation to its total assets. ROA = Net Income / Total Assets
ROA = 960 / 12,000
ROA = 0.08 or 8%
Return on Equity is a way to measure the rate of return on the ownership interest (stakeholders’ equity), in common stock. Measures the firm’s ability or efficiency to generate profit from every dollar invested. ROE = Net Income / Shareholder Equity (assets – liabilities) ROE = 960 / (5,200 – 4,600)
ROE = 960 / 600
ROE = 1.6
I believe that with a return on assets of 8% and a return on equity of 1.6, Pharma is on the right track. For every dollar invested, the company is making 60% return which isn’t too bad.
Chapter 7: Exercise/Problems #11 and #12 (pp. 262-263)
11. [Weighted Average Cost of Capital] Kareem Construction Company has the following amounts of interest bearing debt and common equity capital:
Cost of Capital Short-term loan
***Kareem Construction is in the 30 percent average tax bracket.
Calculate the after-tax WACC for Kareem.
Total Value = Interest bearing accounts + Equity = 200 + 200 + 600 = 1,000,000 WACC = (short-term rate) x (1 – tax rate) x (short-term debt to value) + (long-term debt rate) x (1 – tax rate) X (long-term debt to value) + (equity rate) x (1 – debt value) WACC = [(0.12(1-0.30)(200,000/1,000,000)] + [(0.14(1-0.30)(200,000/1,000,000)] + [0.22(600,000/1,000,000)]
WACC = [(0.12)(0.70)(0.20)] + [(0.14)(0.70)(0.20)] + [(0.22)(0.60)] WACC = [(0.084)(0.20)] + [(0.098)(0.20)] + (0.132)
WACC = (0.0168) + (0.0196) + (0.132)
WACC = 0.1684
WACC = 16.84%
Show how Kareem’s WACC would change if the tax rate dropped to 25 percent and the estimated cost of equity were based on a risk-free rate of 7 percent, a market risk premium of 8 percent, and a systematic risk measure or beta of 2.0.
Cost of Equity = 0.07 + (0.08 x 2.0)
C of E = 0.07 + 0.16
C of E = 0.23
WACC = [(Rate)(1-tax rate)(Beta)] + [(Rate)(1-tax...
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