solution

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 stockâ€™s equity and bond valuations. Dan has sufficient alternative assets and doesnâ€™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 â€˜early cycleâ€™ industry and is already recovering (after a downturn in 2007). Alphabetâ€™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 â€“ 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 â€“ 3 MM at 11% maturing 2015, 5 MM at 8% maturing 2020

QUESTION 19

The Board of Directors is reviewing executive compensation. Which of the following are viable alternatives that would align the CEO with the shareholders?

(1) A combination of quarterly ROE and ROI

(2) A combination of yearly EVA and MVA measures

(3) Bonuses based on 5 year financial performance

(4) A compensation package that is transparent to shareholders

1, 2 and 3

1 and 3

2, 3 and 4

All of the answer choices.

5 points

QUESTION 20

Dan has come across an opportunity to buy an apartment building for $1,250,000, but isnâ€™t sure. He can get a loan for 80% of the buildingâ€™s value at 8%, but because of the risks Danâ€™s own required return is 12%. Given the following annual cash flows, what is the building worth to Dan?

Gross Rents â€“ 210,000

Expected vacancy â€“ 7%

Utilities, Insurance, taxes â€“ 48,000

Interest â€“ 24,000

Maintenance â€“ 10,800

Capital Repair Fund â€“ 10,000

Mgt. Fees â€“ 12,000

Depreciation â€“ 32,000

$1,020,833

$ 754,166

$1,037,500

$1,556,250 (50% credit)

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