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cost of equity of Anderson's Furniture Outlet

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1. Anderson's Furniture Outlet is levered firm with a tax rate of 34% and expected earnings before interest and taxes (EBIT) of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are currently selling at par value. For simplicity, you may assume perpetual EBIT and perpetual loans.

The company's financial analyst suggests two comparable firms for benchmarking purpose.

The Boyles Design Studio is private firm but it has a debt-to-equity ratio of 0.2 and its outstanding bonds are publicly traded with a yield to maturity of 5%. There is no information about Boyles' stock beta since it has no publicly traded shares.
The Ethan Stores is an all-equity firm with publicly traded shares and the company's cost of equity capital is 10%.

According to the MM theory, what should be the cost of equity of Anderson's Furniture Outlet?

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MM Theory
1. Anderson's Furniture Outlet is levered firm with a tax rate of 34% and expected earnings before interest and taxes (EBIT) of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are currently selling at par value. For simplicity, you may assume perpetual EBIT and perpetual loans.

The company's financial analyst suggests two comparable firms for benchmarking purpose.

The Boyles Design Studio is private firm but it has a debt-to-equity ratio of 0.2 and its ...

Solution Summary

The cost of equity of Anderson's Furniture Outlet is determined.

$2.19
See Also This Related BrainMass Solution

Finance Assignment: Working Capital Management

** Please see the attached file for the complete problem description **

Anderson Furniture Company manufactures furniture and sells its products to department stores, retail furniture stores, hotels, and motels throughout the United States and Canada. The firm has nine manufacturing plants located in Virginia, North Carolina, and Georgia.

The company was founded by Edward G. Anderson in 1906 and has been managed by members of the Anderson family since that time. E.G. Anderson III is currently chairman and president of the company. The treasurer and controller of the company is Claire White, who was hired away from a competing furniture company a few years ago. Anderson owns 35 percent of the company stock of the company and (along with the shares of the firm owned by relatives and employees) has effective control over all of the firm's decisions.

Financial data relating to last year's (2007) operations, along with relevant industry comparisons, are shown in table 16C.1 (see attachment). The firm's overall rates of return on equity and total assets have been around the industry average over the past several years -- sometimes slightly above average and sometimes below average.
The company is currently operating its plants near full capacity and would like to build a new plant in Georgia at a cost of approximately $7.5 million. White has been exploring various alternative methods of financing this expansion and has been unsuccessful thus far in developing an acceptable plan. The sale of new common stock is not feasible at this time because of depressed stock market prices. Likewise, Anderson's banker has advised the firm that the use of additional long-term debt or lease financing is not possible at this time, given the firm's large amount of long-term debt currently outstanding and its relatively low times interest earned ratio.
Anderson has ruled out a cut in the firm's dividend as a means of accumulating the required financing. The only other possible sources of financing available to the firm at this time, according to White, appear to be a reduction in working capital (current assets), an increase in short term liabilities, or both.

Upon learning of these proposed financing methods, Anderson expressed concern about the effect these plans might have on liquidity and risk of the firm. White replied that the firm currently follows a very conservative working capital policy and that these financing methods would not increase shareholder risk significantly. As evidence, she cited the firm´s relatively high current and quick ratios. Anderson was unconvinced and asked White to provide additional information on the effects of these financing plans on the firm's financial status.

Answer 9 questions (attached) to the case above in Excel and use Excel formulas to arrive at the solutions.

The attachment shows the questions and the financial data of the Anderson company.

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