ABC Plumbing Corp.   and  Income/Balance sheet . Using the various ratios and assumptions project the stock price for the case study company and new issues of stock based on the statements. Be sure to include the following:

1. Incorporate and update the information given in Table 1 to reflect the changes for the upcoming year
2. Prepare the income statement and balance sheet for next year based on these assumptions: 
3. (a) cash, fixed assets, payables and accruals will grow with sales;
4.  (b) the current composition of interestbearing debts, which includes short-term bank loans and long term bonds, will be maintained for next year; (c) a tax rate of 40%; 
5. (d) 10% interest rate on all interest-bearing debts; 
6. (e) 50 million common shares outstanding
7. The current market price of ABC’s common stocks is at $23.05. If all assumptions are realized, what is your estimate for ABC’s stock a year from now based on today’s P/E ratio?
8. If the growth rate of ABC next year is only 6%, but all other assumptions are maintained, what will ABC’s stock price be? If this growth rate turns out to be a better-than-expected rate of 12%, how much will this stock be worth a year from now based on this model?

 

ABC PLUMBING CORPORATION

ABC Plumbing (ABC), an Atlanta-based corporation, has been installing plumbing systems in residential construction sites for an extended number of years. All through these years, the ABC did not implement an integrated short- and long-term financial plan to guide its operations and assess potential

bottlenecks. To begin with, Ann Smith, the newly hired CFO, is keenly interested to mobilize all departments and resources to come up with a well coordinated financial forecast for this coming year. She believes that the experience gained from annual short-term forecast will help her implement a much thought out long-term financial planning in the upcoming year. Smith figured out that revenue for the current year is $3 billion, and the marketing department projects a 10% increase in sales for next year. Some estimates of selected ratios and the balance sheet and

income statement for the current year are given in Table 1 and 2, respectively. Smith was also informed that the company is currently operating at full capacity, but is not quite sure about it. Armed with the accounting data made available to her, Smith initiated a meeting with the CEO and other top executives to discuss her plans to implement an annual financial forecast for the following year. They all expressed

their desire to get this plan completed and agreed to cooperate with her. Together, they were able to review these ratios and compare them with industry standards. They all agreed that significant step must be taken to improve the financial performance of the firm in coming year. Smith made it clear to everyone in the meeting that lack of coordination and integrated financial plans may trigger a potential

takeover of the firm whereby they could all lose their jobs. As a recent graduate from a business school, suppose you are recently hired as Smith’s assistant

to help her develop financial forecast for the upcoming year. Smith asks you to begin your task by first obtaining updated information from the various departments regarding production, inventory, receivable, and payables. Through your inquiry, you are able to gather the following valuable information from the

department managers and the CFO:

 

1. Due to the recent change in credit terms granted to clients, ABC’s current level of average collection period or Days’ Sales Outstanding (DSO) will be reduced to 35 in line with the industry average of 32.41. By offering discount incentives to encourage prompt payment and through favorable credit terms the receivables manger expects to meet this targeted goal.
2. A relatively new inventory management system that rearranged the orderly flow of plumbing parts has begun to yield positive improvement. This efficiency gain is expected to increase inventory turnover to 6 times annually.
3.  Most ABC’s construction workers belong to the labor union and their wages are contractually pegged to COLA (Cost-Of-Living-Adjustment). The recent deflation resulting from the current recession has produced a negative COLA figure. This will take effect when its workers sign ABC’s new wage contracts at the beginning of the year. According to payables manager, this reduction of wages is estimated to yield a lower operating costs-to-sales ratio of 90% for the coming year.
4. ABC has a good credit in the past. With prevailing interest rates currently at a historically low level, Smith has decided to redeem ABC’s high-rate bonds issued six years ago with a new low rate. This will reduce ABC’s interest-bearing debt and result in a lower liability-to-asset ratio of 30%.
5.  ABC’s current dividend payout ratio is 28.99% while the average payout ratio for the plumbing industry is 22%. Smith has planned to cut down this ratio to 25% of retained earnings to make room for potential growth. As shareholders have in the past favored capital gains over cash dividends, Smith projects that the dividend reduction will not have much of a negative impact on the value of the firm.
6.  ABC’s current dividend payout ratio is 28.99% while the average payout ratio for the plumbing industry is 22%. Smith has planned to cut down this ratio to 25% of retained earnings to make room for potential growth. As shareholders have in the past favored capital gains over cash dividends, Smith projects that the dividend reduction will not have much of a negative impact on the value of the firm.

 

Table 1: Selected Ratios: ABC Plumbing, INC. and Its Industry

 

	ABC: Current Year	Industry
Operating Costs/Sales	93.33%	88.50%
Receivables/Sales	11.67%	8.88%
Inventories/Sales	20.00%	9.12%
Liability Assets	35.00%	25.00%
Payout Ratio	28.99%	22.00%

 

Table 2: Income Statement & Balance Sheet

 

Income Statement	Current Year
Sales