Dan no longer works for Alphabet, but he has a relatively large amount of his personal wealth tied up in both company stock and debt. Consequently, he would like an objective review of the company today and its future prospects. He would also like an opinion on the stock’s equity and bond valuations. Dan has sufficient alternative assets and doesn’t need to sell his ABCD stock or bonds, but he is becoming concerned about increasing inflation and is reviewing all of his holdings.

Economic Environment:

The risk-free rate is at 4.2%. The economy is just coming out of a recession, but Alphabet is in an ‘early cycle’ industry and is already recovering (after a downturn in 2007). Alphabet’s earnings are expected to grow 12%. Inflation is running at 3%, but both Dan and economists are concerned that inflation could rise to 6% within five years.

Alphabet Corp - Income Statement

Period Ending		2010	2009	2008
Total Revenue		45,000,000	37,500,000	34,000,000
Cost of Revenue		22,000,000	18,750,000	18,700,000
Gross Profit		23,000,000	18,750,000	15,300,000
Operating Expenses
	Research Development	1,800,000	800,000	750,000
	Selling General and Administrative	7,800,000	6,750,000	6,300,000
	Total Operating Expenses	9,600,000	7,550,000	7,050,000
EBIT		13,400,000	11,200,000	8,250,000
	Interest Expense	950,000	1,350,000	1,400,000
EBT		12,450,000	9,850,000	6,850,000
	Income Tax Expense	3,975,000	2,950,000	2,050,000
Net Income Applicable To Common Shares (EAT)		$8,475,000	$6,900,000	$4,800,000
Dividend per share		$.385	$.31	$.20

Alphabet Corp – Balance Sheet

Period Ending		2010	2009	2008
Assets
Current Assets
	Cash And Cash Equivalents	2,500,000	3,200,000	2,200,000
	Net Receivables	9,000,000	5,500,000	3,400,000
	Inventory	5,500,000	5,000,000	4,000,000
Total Current Assets		17,000,000	13,700,000	9,600,000
Long Term Investments		3,000,000	4,000,000	4,000,000
Property Plant and Equipment		7,750,000	8,500,000	8,500,000
Goodwill		1,250,000	1,350,000	1,400,000
Total Assets		29,000,000	27,550,000	23,500,000
Current Liabilities
	Accounts Payable	4,500,000	3,800,000	3,500,000
	Other Current Liabilities	900,000	750,000	800,000
	LT Debt Due	-	3,000,000	-
Total Current Liabilities		5,400,000	7,550,000	4,300,000
Long Term Debt		8,000,000	8,000,000	11,000,000
Total Liabilities		13,400,000	15,550,000	15,300,000
Stockholders' Equity
Preferred Stock		-	-	-
Common Stock (11 MM shares @ 1.00)		11,000,000	11,000,000	11,000,000
Retained Earnings		4,600,000	1,000,000	-2,800,000
Total Stockholder Equity		15,600,000	12,000,000	8,200,000

LT Debt – 3 MM at 11% maturing 2015, 5 MM at 8% maturing 2020.

QUESTION 1

Alphabet’s business competitors sell at a price-to-sales multiple of 2.7x, a price-to-earnings multiple of 15x, and a price-to-book ratio of 8x. What is the most accurate range of valuation per share that you would place on Alphabet when applying the above multiples to its 2010 financial data?

		$11.00-$11.60
		$16-$17
		$10.50-$13.50
		$5.25-$5.75

QUESTION 2

Dan’s stock was worth $7.00 when he received shares 4 years ago. It has paid dividends in 2008 – 2010. If the stock is worth $11.50 at the end of 2010, what is Dan’s HPR?

		77%
		177%
		64%
		19%

QUESTION 3

Because ABCD pays out 50% of it’s earnings as dividends, its expected growth rate is reduced to 6%. If Dan’s discount rate is 12%, what is ABCD’s approximate fair value?

		$11.25
		$6.40
		$3.40
		$6.80

QUESTION 4

Dan asks for your advice about financing acquisitions. Which of the following responses are correct?

(1) Debt financing allows the company to write-off interest payments prior to calculating taxes due

(2) Adding some debt financing to an all equity firm will decrease the average weighted cost of capital

(3) The before-tax cost of debt is the important rate to use in the weighted average cost of capital calculation.

(4) Adding more debt will typically increase the financial risk of a company

		All of the answer choices
		1, 2 and 4
		1 and 2
		3 and 4

QUESTION 5

Alphabet is considering the purchase of a publicly-traded competitor. The purchase price for the business is $3,500,000.

Year	After-tax Cashflows
1	$150,000
2	$340,000
3	$420,000
4	$500,000
5	$600,000
6-10	$640,000

Answer rating: 100% (QA)

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