A

first

-

year analyst

in your

investment bank

s

ent

you

the

attached

projected

income

statement and balance sheet for General Products Inc

over the next two years.

Year 0

ended yesterday.

Year 1

cash flows will be received exactly one year from today.

The

firm

s cost of debt is 7.5% and the corporate income tax rate is 35%. If the firm was

3

financed only wi

th equity, the cost of equity w

ould be 1

2

%. The firm

s

current

financing

structure in terms of book values can be seen in the balance sheet. The

long

-

term

target

capital struc

ture is

30% debt and 70% equity. After

the first

two years, the firm

s

free

cash flow

will

continue to

grow

at

3% per year

forever

.

a.

Calculate the

firm

s free ca

sh flow

s

for years 1 and 2.

b.

What is the

firm

s

cost of equity?

c.

What is the firm

s WACC?

d.

What is the value of the firm?

e.

What is the

value of the firm

s equity?

f.

What crucial mistake did

the analyst make in projecting

t

he firm

s assets?

g.

What

is the firm

s current capit

al structure

as of year 0

based o

n the market

values of the firm

s debt and equity? (Assume the market value of the debt is

equal to the book value of the debt).

Is the projected issuance of debt consistent

with the target

capital

structure mentioned above?

Or does the firm have to

issue more

/

less debt?

INCOME STATEMENT Years 1 0 2 Sales Cost of Goods Sold (COGS) Gross Profit Operating Expenses: Selling, General and Administrative (SG&A) Depreciation and Amortization (D&A) Total Operating Expenses Operating Income (EBIT) Interest Expense (Net) Earnings Before Tax Taxes Net Income 150,000 190,000 210,000 80,000100,000 105,000 70,00090,000 105,000 33,00037,000 42,000 18,00020,000 22,000 51,00057,000 64,000 19,00033,000 41,000 4,500 4,650 4,800 14,500 28,350 36,200 5,075 9,923 12,670 9,425 18,428 23,530 INCOME STATEMENT Years 1 0 2 Sales Cost of Goods Sold (COGS) Gross Profit Operating Expenses: Selling, General and Administrative (SG&A) Depreciation and Amortization (D&A) Total Operating Expenses Operating Income (EBIT) Interest Expense (Net) Earnings Before Tax Taxes Net Income 150,000 190,000 210,000 80,000100,000 105,000 70,00090,000 105,000 33,00037,000 42,000 18,00020,000 22,000 51,00057,000 64,000 19,00033,000 41,000 4,500 4,650 4,800 14,500 28,350 36,200 5,075 9,923 12,670 9,425 18,428 23,530