Question

The four questions below analyze the same company. The information below will be needed to answer all questions. Consider the following information regarding ABC Corporation.

2009

2010

Sales ($ millions)

1000

1112

Cost of Goods Sold ($ millions)

500

556

Other Expenses ($ millions)

100

111

Depreciation ($ millions)

100

100

Interest Expense ($ millions)

50

55

Total Current Assets ($ millions)

600

700

Net Fixed Assets ($ millions)

1800

2000

Total Current Liabilities ($ millions)

450

550

Long-term Liabilities ($ millions)

900

975

• The firm’s plowback ratio is 60%

• The firm’s tax rate is 40%

• The company has 30 million shares outstanding. The current stock price is $35.

• The company has two bond issues outstanding. The first issue is 100,000 bonds that have YTM of 5%, coupon rate of 7%, face value of $1000, and mature in 7 years. The second issue is 500,000 bonds with YTM of 8%, face value of $1500, and mature in 13 years. These bonds are currently selling for $1200.

• The expected return on the market is 11%. The risk-free rate is 4%.

• ABC’s beta is 2.15

1. What is the company’s WACC?

2. What is the company’s internal growth rate (IGR).

3. Use the IGR and the required return on the stock to find the financial data to find the current dividend. What does the dividend growth model predict the stock price to be?

4. Which of the following might be a valid reason for the large discrepancy between the predicted stock price from #3 and the actual stock price of $35?

a. The market expects the company to grow at a faster rate than the internal growth rate.

b. The market expects the company to grow at a slower rate than the internal growth rate.

c. The market requires a higher return than the one you have using CAPM?

d. The company is doing very poorly.

e. The company is doing very well.

Answer 1