HOMEWORK SET IV

I XYZ Company had the following income statement last year:

Revenue
1,000,000
Variable costs
600,000
Rent
50,000
Depreciation
40,000
It was capitalized with 1,250,000 owners equity, 600,000 bank loans, for which it
pays 6%. It has 800,000 in equipment and 50,000 in cash. Assume a 35%
corporate profits tax rate.
A]

Calculate XYZs (AT)ROE and coverage ratio.

EBITDA=Revenue-Variable costs-Rent=1,000-600-50=350 (thousands)

EBIT=EBITDA-Depreciation=350-40=310 (thousands)
EBT=EBIT-Interest=310-600*6%=274 (thousands)
Net Income=EBT-Tax=274*(1-0.35)=178.1 (thousands)
ROE=Net Income/Equity=178.1/1250=14.248%
Coverage ratio=EBITDA/Interest=350/(600*6%)=9.72
B]
For this year XYZ borrows an additional $400,000 from its bank at the same
interest rate in order to purchase that amount more in equipment and expand
operations. As a result, revenue and variable costs both increase 20%. And
depreciation rises accordingly. Calculate the new ROE and coverage ratio.
Depreciation was 5% because 40k/800k, and so its still 5% of the new number.
Equity didnt increase even though we bought new equipment, b/c we didnt gain or
lose equity, but gained debt and equipment.
Revenue=1,000*1.2=1200 (thousands)
Variable cost=600*1.2=720 (thousands)
Rent=50 (thousands)
EBITDA= Revenue-Variable costs-Rent=1200-720-50=430 (thousands)
Depreciation=((800+400)/800)*40=60 (thousands)
EBIT= EBITDA-Depreciation=430-60=370 (thousands)
EBT=EBIT-Interest=370-(600+400)*6%=310 (thousands)
Net Income=EBT-Tax=310*(1-0.35)=201.5 (thousands)
ROE=Net Income/Equity=201.5/1250=16.12%
Coverage ratio=EBITDA/Interest=430/((600+400)*6%)=7.17
C]
Instead of funding the new equipment as in B], the company borrows 200,000
and raises 200,000 in new equity. Redo the calculations.
Revenue=1,000*1.2=1200 (thousands)

Variable cost=600*1.2=720 (thousands)

Rent=50 (thousands)
EBITDA= Revenue-Variable costs-Rent=1200-720-50=430 (thousands)
Depreciation=((800+400)/800)*40=60 (thousands)
EBIT= EBITDA-Depreciation=430-60=370 (thousands)
EBT=EBIT-Interest=370-(600+200)*6%=322 (thousands)
Net Income=EBT-Tax=322*(1-0.35)=209.3 (thousands)
ROE=Net Income/Equity=209.3/(1250+200)=14.43%
Coverage ratio=EBITDA/Interest=430/((600+200)*6%)=8.96

D]
XYZ does not expand operations, so does not need to borrow more funds.
Instead, to increase ROE, it borrows 200,000 and returns that amount to the equity
holders. Redo the ROE and coverage calculations.
EBITDA=Revenue-Variable costs-Rent=1,000-600-50=350 (thousands)
EBIT=EBITDA-Depreciation=350-40=310 (thousands)
Debt=600+200=800 (thousands)
EBT=EBIT-Interest=310-800*6%=262 (thousands)
Net Income=EBT-Tax=262*(1-0.35)=170.3 (thousands)
Equity=1250-200=1050 (thousands)
ROE=Net Income/Equity=170.3/1050=16.22%
Coverage ratio=EBITDA/Interest=350/(800*6%)=7.29

II
Under the original assumptions for XYZ Company in question I, the stock
market has given it a market capitalization of 1,500,000 (100,000 shares
outstanding). A hedge fund is formed to purchase 1,000 shares of XYZ. The funds
leverage ratio is 4:1. What is its book value?
Book Value per share=1250/100=12.5
Market Value per share=1500/100=15
Payment of hedge fund=15*1,000=15,000
The book value of the fund=15,000*1/4=3750
XYZ now decides to employ strategy B above. As a result, its stock price
appreciates 10%. The hedge fund marks-to-market. What is the hedge funds book
value under B compared to its original? What is XYZs book value under B
compared to its original?
Market Value per share=15*1.1=16.5
Payment of hedge fund=16.5*1,000=16,500

The book value of the fund=16,500*1/4=4125

So the hedge funds book value under B increase by (12,375-11,250)=1,125
compared to its original
The XYZs book value = (100,0001000)*12.5+1000*16.5=1,237,500+16,500=1,254,000
The change of XYZs book value = 1,254,000-1,250,000=4,000
Another way to calculate the book value of XYZ is:
The change of XYZs book value = (15*1.1-12.5)*1000=4,000

III
A]
Rutgers Rotisserie (RR) had $50 million in owners equity at the start of 2015.
A million shares were outstanding, with a price at 20% premium to book value.
What were its market value and book value; market value-per-share and book valueper-share?
Book value = 50 million
Book value per share = 50 million /1 million= 50
Market value per share = 50 * 1.2 = 60
Market value = 60*1million = 60 million
B]
RR retained $5 million of its after-tax profits in 2015. What were its market
value and book value; market value-per-share and book value-per-share as of Jan 2
2016, assuming same relationship between market and book value-per-share?
Book value = 50 + 5 = 55 million
Book value per share = 55 million /1 million= 55
Market value per share = 55 * 1.2 = 66
Market value = 66 * 1 million = 66 million

C]
Given the situation in B], RR issues an additional 100,000 shares on Jan 3 at a
2% discount to its Jan 2 price. What are its market value and book value; market
value-per-share and book value-per-share?
Market value per share = 66 * (1-2%) = 64.68
Book value = 55 million + 64.68 * 100,000 = 61.468 million
Book value per share = 61.468 million / 1.1 million = 55.88