An analyst with a mutual fund is considering buying a FCS Inc corporate bond. She has collected the balance sheet information and income statement info for FCS, as shown in Table 1 (values in thousands). Using the funds internal rating system, shown in Table 2, she computes a set of ratios to determine the appropriate risk premium for the bond. Balance Sheet Income Statement Current Assets $ 4,735 Revenue $ 18,500 $ 14,050 Fixed Assets $ 43,225 47,960 Operating and Admin. Expenses Operating Income before D&A $ 4,450 Total Assets Current Liabilities $ $ 4,500 Depreciation & Amortization $ 1,675 Long-term Debt $ 10,000 Interest Expense $ 942 Total Liabilities $ 14,500 $ 1,833 $ 33,460 Taxes $ 641 Shareholder Equity Total Liabilities & Shareholder Equity Table 1. $ 47,960 Net income $ 1,192 Rating Table Bond Rating Interest Coverage Leverage Current Ratio Risk Premium AA 5.0 to 6.0 0.25 to 0.30 1.15 to 1.25 0.30% A 4.0 to 5.0 0.30 to 0.40 1.00 to 1.15 0.50% BBB 3.0 to 4.0 0.40 to 0.50 0.90 to 1.10 1.00% BB 2.0 to 3.0 0.50 to 0.60 0.75 to 0.90 1.25% Table 2. In the fund's internal rating system, the interest coverage is defined as EBITDA divided by interest expense. The leverage is defined as long-term debt divided by book value of equity. The current ratio is defined as current assets divided by current liabilities. a) Compute the ratios to determine the appropriate bond rating for the FCS Inc bond. The market debt ratio (MDR) is defined as the book value of total debt divided by the sum of the book value of total debt and the market value of equity. Assume that 1/3 of the current liabilities on FCS Inc's balance sheet are short-term debt. Currently, FCS Inc's MDR is 0.40. The beta of the company's stock is 1.20. The bond is currently trading at a risk premium of 55 basis points b) Assuming a risk-free rate of 3.0%, a market risk premium of 6.0%, and a tax rate of 25%, find the weighted average cost of capital. c) FCS Inc has reached the stable growth stage. Its capital expenditures are 1.12x depreciation, and the change in net working capital is zero. Find the implied growth rate for the free cash flow to the firm (FCFF). An analyst with a mutual fund is considering buying a FCS Inc corporate bond. She has collected the balance sheet information and income statement info for FCS, as shown in Table 1 (values in thousands). Using the funds internal rating system, shown in Table 2, she computes a set of ratios to determine the appropriate risk premium for the bond. Balance Sheet Income Statement Current Assets $ 4,735 Revenue $ 18,500 $ 14,050 Fixed Assets $ 43,225 47,960 Operating and Admin. Expenses Operating Income before D&A $ 4,450 Total Assets Current Liabilities $ $ 4,500 Depreciation & Amortization $ 1,675 Long-term Debt $ 10,000 Interest Expense $ 942 Total Liabilities $ 14,500 $ 1,833 $ 33,460 Taxes $ 641 Shareholder Equity Total Liabilities & Shareholder Equity Table 1. $ 47,960 Net income $ 1,192 Rating Table Bond Rating Interest Coverage Leverage Current Ratio Risk Premium AA 5.0 to 6.0 0.25 to 0.30 1.15 to 1.25 0.30% A 4.0 to 5.0 0.30 to 0.40 1.00 to 1.15 0.50% BBB 3.0 to 4.0 0.40 to 0.50 0.90 to 1.10 1.00% BB 2.0 to 3.0 0.50 to 0.60 0.75 to 0.90 1.25% Table 2. In the fund's internal rating system, the interest coverage is defined as EBITDA divided by interest expense. The leverage is defined as long-term debt divided by book value of equity. The current ratio is defined as current assets divided by current liabilities. a) Compute the ratios to determine the appropriate bond rating for the FCS Inc bond. The market debt ratio (MDR) is defined as the book value of total debt divided by the sum of the book value of total debt and the market value of equity. Assume that 1/3 of the current liabilities on FCS Inc's balance sheet are short-term debt. Currently, FCS Inc's MDR is 0.40. The beta of the company's stock is 1.20. The bond is currently trading at a risk premium of 55 basis points b) Assuming a risk-free rate of 3.0%, a market risk premium of 6.0%, and a tax rate of 25%, find the weighted average cost of capital. c) FCS Inc has reached the stable growth stage. Its capital expenditures are 1.12x depreciation, and the change in net working capital is zero. Find the implied growth rate for the free cash flow to the firm (FCFF)
