I need help on Part C please

Financial Analysis Exercise IV

Part A: Weighted Average Cost of Capital (WACC)

Here again is the formula for WACC. For simplicity the term for preferred stock has been removed:

Go to http://thatswacc.com/[1] and enter the ticker symbol for the stock you selected and click on the tab entitled Calculate WACC.

Complete the following tables:

Name of Company/Stock	International Business Machines
Ticker Symbol	IBM

From the http://thatswacc.com/ results for your company:

WACC	7.48%
Cost of debt, iD	1.16%
Corporate tax rate, TC	18.12%
Total debt, D	$39,889,000,000
Total equity, E	$142,900,000,000
Total firm value, V	$183,205,500,000
Cost of equity, iE	9.32%

CAPM Components

Beta,	.79
Historical market return, iM	Assumed 11%
Risk-free rate, iF	Assumed 3%

Using data in the table confirm the accuracy of the sites WACC calculation:

Weight of Equity		78.33%
Weighted Average Cost of Equity	E	7.30%
Weight of Debt		21.67%
Pre-Tax Weighted Average Cost of Debt	D	.251%
After-Tax Weighted Cost of Debt	D (1- TC)	.206%
Weighted Average Cost of Capital	= iE + iD (1-Tc)	7.51%

Part B: Dividend Payout and Growth Ratios

Recall from Module 1 the following two ratios:

Internal growth rate = (ROA RR) / [1-(ROA RR)] (Eq. 3-30)

where RR = Retention ratio = (Addition to retained earnings)/Net income (Eq. 3-31)

The internal growth rate measures the amount of growth a firm can sustain if it uses only internal financing (retained earnings) to increase assets

Sustainable growth rate = (ROE RR) / [1-(ROE RR)] (Eq. 3-33)

If the firm uses retained earnings to support asset growth, the firms capital structure will change over time, i.e., the share of equity will increase relative to debt

To maintain the same capital structure managers must use both debt and equity financing to support asset growth

The sustainable growth rate measures the amount of growth a firm can achieve using internal equity and maintaining a constant debt ratio

1. For the firm selected for Part A, calculate its internal growth rate for the last fiscal year:

= (ROA RR) / [1-(ROA RR)]

=(.1194*.6316)/(1-(.1194*.6316)

=.07542/.92458

=.0815 or 8.15%

2. Calculate the firms sustainable growth rate for the last fiscal year:

= (ROE RR) / [1-(ROE RR)]

=(.9248*.6316)/(1-(.9248*.6316))

= .5841/.4159 = 1.4047 or 140.47%

Part C. Need help here

Consider your results for Parts A and B. If the chosen firm grows at its internal growth rate, increasing assets only with its retained earnings, how will this likely affect its WACC? Show calculations.

If the chosen firm grows at its sustainable growth rate with increases in both its retained earnings and debt, maintaining a constant debt ratio, how will this affect its WACC?

If the chosen firm attempts to grow faster than its sustainable growth rate with modest increases in its debt ratio, how will this likely affect its WACC? What about very large increases in its debt ratio? Explain.

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