Question 1 A first-year analyst in your investment bank sent 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 financed only with equity, the cost of equity would be 12%. The firm's current financing structure in terms of book values can be seen in the balance sheet. The long-term target capital structure 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 cash flows 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 the firm's assets? (Look carefully at what will happen to each of the firm's assets as more years go by.) g. What is the firm's current capital structure as of year 0 based on 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 2 150,000 190,000 210,000 80,000 100,000 105,000 70,000 90,000 105,000 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 33,000 18,000 51,000 19,000 4,500 14,500 5,075 9,425 37,000 20,000 57,000 33,000 4,650 28,350 9,923 18,428 42,000 22,000 64,000 41,000 4,800 36,200 12,670 23,530 BALANCE SHEET Years 0 2 Current Assets Cash Accounts Receivable Inventory Total Current Assets 25,000 15,000 18,000 58,000 44,428 68,458 18,000 20,000 21,000 22,000 83,428 110,458 Gross Property, Plant & Equipment Less Accumulated Depreciation & Amortization Net Property, Plant & Equipment Total Assets 120,000 135,000 150,000 30,000 50,000 72,000 90,000 85,000 78,000 148,000 168,428 188,458 Current Liabilities Accounts Payable Total Current Liabilities 14,000 14,000 17,000 17,000 17,500 17,500 Long-term Debt Shareholder's Equity Total Liabilities 60,000 74,000 148,000 62,000 64,000 89,428 106,958 168,428 188,458 Question 1 A first-year analyst in your investment bank sent 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 financed only with equity, the cost of equity would be 12%. The firm's current financing structure in terms of book values can be seen in the balance sheet. The long-term target capital structure 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 cash flows 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 the firm's assets? (Look carefully at what will happen to each of the firm's assets as more years go by.) g. What is the firm's current capital structure as of year 0 based on 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 2 150,000 190,000 210,000 80,000 100,000 105,000 70,000 90,000 105,000 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 33,000 18,000 51,000 19,000 4,500 14,500 5,075 9,425 37,000 20,000 57,000 33,000 4,650 28,350 9,923 18,428 42,000 22,000 64,000 41,000 4,800 36,200 12,670 23,530 BALANCE SHEET Years 0 2 Current Assets Cash Accounts Receivable Inventory Total Current Assets 25,000 15,000 18,000 58,000 44,428 68,458 18,000 20,000 21,000 22,000 83,428 110,458 Gross Property, Plant & Equipment Less Accumulated Depreciation & Amortization Net Property, Plant & Equipment Total Assets 120,000 135,000 150,000 30,000 50,000 72,000 90,000 85,000 78,000 148,000 168,428 188,458 Current Liabilities Accounts Payable Total Current Liabilities 14,000 14,000 17,000 17,000 17,500 17,500 Long-term Debt Shareholder's Equity Total Liabilities 60,000 74,000 148,000 62,000 64,000 89,428 106,958 168,428 188,458