# Times-interest ratio;time burden ratio;net present value

1

ABC Waterhouse's free cash flow next year will be $250 million and it is widely expected to grow at a 5 percent annual rate indefinitely.

The company's weighted average cost of capital is 11 percent, the market value of its liabilities is $2.5 billion, and it has 32 million shares outstanding.

a. Estimate the price per share of ABC's common stock.

b. A private equity firm believes that by selling the company 200 water towers, increasing the work day to eight hours, and instituting other cost savings, it can increase ABC's free cash flow next year to $260 billion and can add a full percentage point to ABC's growth rate without affecting its cost of capital. What is the maximum price per share the private equity firm can justify bidding for control of ABC?

2

As the Financial vice president for Bear Enterprises, you have the following information:

Expected net income after tax next year before new financing $60,000,000

Sinking Fund payments due next year on existing debt 20,000,000

Interest due next year on existing debt 18,000,000

Conpany Tax rate 25%

Common Stock Price, per share 17

Common Shares outstanding 22,000,000

a. Calculate Bear's times-interest earned ratio for next year assuming the firm raises $60 Million of new debt at an

interest rate of 9 percent.

b. Calculate Bears times-burden covered ratio for the next year assuming annual sinking-fund payments on the new

debt will equal $5 Million

c. Calculate next years earnings per share assuming Bear raises the $60 Million of new debt.

d. Calculate next years times-interest earned ratio, times-burden-covered ratio, and earnings per share if Bear sells

$2 Million new shares at $17.00 per share instead of raising new debt.

3

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An investment costing $70,000 promises an after tax cash flow of $28,000 per year for 7 years.

a. Find the investment's accounting rate of return and its payback period.

b. Find the investment's net present value at 20 percent discount rate.

c. Find the investment's profitability index at a 20 percent discount rate.

d. Find the investment's internal rate of return.

4

A Company is considering two alternative methods of producing a new product. The relevant data concerning the

alterrnatives are presented below.

Alternative Alternative

I II

Initial Investment 50,000 110,000

Annual receipts 36,000 50,000

Annual disbursements 16,000 10,000

Annual depreciation 12,000 16,000

Expected Life 5 years 7 years

Salvage Value 0 0

At the end of the useful life of whatever equipment is chosen the product will be discontinued. The company's tax

rate is 50 percent, and its cost of capital is 11 percent.

a. Calculate the Net Present Value of each alternative

b. Calculate the internal rate of return for each alternative.

d. If the company is not under capital rationing, which alternative should be chosen? Why?

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1

ABC Waterhouse's free cash flow next year will be $250 million and it is widely expected to grow at a 5 percent annual rate indefinitely.

The company's weighted average cost of capital is 11 percent, the market value of its liabilities is $2.5 billion, and it has 32 million shares outstanding.

a. Estimate the price per share of ABC's common stock.

FCF1 $250 million

g 5%

r 11%

Market value of firm =FCF1/(r-g) $4,166.67 million

Market value of liabilities $2,500.00 million

Market value of equity $1,666.67 million

No. of shares outstanding 32.00 million

Price per share $52.08

b. A private equity firm believes that by selling the company 200 water towers, increasing the work day to eight hours, and instituting other cost savings, it can increase ABC's free cash flow next year to $260 million and can add a full percentage point to ABC's growth rate without affecting its cost of capital. What is the maximum price per share the private equity firm can justify bidding for control of ABC?

FCF1 $260 million

g 6%

r 11%

Market value of firm =FCF1/(r-g) $5,200.00 million

Market value of liabilities $2,500.00 million

Market value of equity $2,700.00 million

No. of shares outstanding 32.00 million

Price per share $84.38

The PE firm can justify upto $84.38 for the equity of ABC

2

As the Financial vice president for Bear Enterprises, you have the following information:

Expected net income after tax next year before new financing $60,000,000

Sinking Fund payments due next year on existing ...

#### Solution Summary

This post shows how to calculate times-interest ratio, time burden ratio, next year earning, investment's accounting rate of return, pay back period, net present value and profitability index

Financial Statement Analysis/Accounting

1. The following information is taken from the financial statements of Universal Fertilizers, Inc. for it fiscal year ended December 31, 2004:

Debt $25.0 million

Shareholders' Equity 30.0 million

Interest expense 1.2 million

Times interest earned 3.0x

The Company's financial statement footnotes include the following:

(i) The Company has committed itself by non-cancelable contract (starting in 2005) to purchase a total of $18 million of phosphates over the next five years from OCP, which is 100% owned by the Moroccan government. The estimated present value of these payments is $9.12 million. The Company has secured the contract with a standby letter of credit running to the benefit of OCP. If the letter of credit is drawn upon, the Company must reimburse the issuing bank with which it has its main banking relationship. The Moroccan government has pledged the contract and 50% of the proceeds of the sale of the phosphates to the World Bank to retire some of the indebtedness that Morocco owes to the World Bank.

(ii) The Company has guaranteed a $15 million, 10% unsecured debenture issue, due in 2011, issued by Agro Transports Ltd., a non-consolidated 40%-owned affiliate that operates ocean going bulk cargo ships. At the present time, the affiliate has large excess shipping capacity as does the world in general and its financial situation is uncertain.

(iii) On January 2, 2004, the Company entered into an operating lease with future payments of $60 million ($7.5 million/year) with a discounted present value of $30 million. The lease has a number of renewal options going out over a 20 year period.

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