Accounting solution based on balance sheet


Published on

This is an accounting solution based on balance sheet. For accounting homework help, please visit our website

Published in: Education
  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Accounting solution based on balance sheet

  1. 1. Accounting solution based on balance sheet:Tukar Inc, a manufacturer of portable air conditioning units in phoenix, is planning to expand its operations due toincreasing market demand. Using the EFN Model, Tukar will need 6.0 million to expand and decide whether to usedebt or equity fiancing. Debt can be sold at a cost of 10% while new equity can be sold at $32.00 per share. As aconsequence of an earlier IPO, the company has one million shares of below has been gathered for analysis andrecommendation.Air Conditioning Industry RatiosCurrent Ratio 2.0xSales to total assets 2.1xCurrent Debt to total assets 36%Long-term debt to net worth 32%Total debt to total assets 52%Fixed Coverage Ratio 6.0xNet income to sales 4%Return on total assets 9%Net income to net worth 18% Balance Sheet –Tukar Inc 12-31-2006Assets: Liabilities:Cash 2,520 Current liabilities 10,000A/R 10,520 Long term debt (10%) 3,600Inventories 15,200 Total Debt 13,600TCA 28,240 Net Worth 26,400Net Fixed Assets 11,760 Total liabilities $40,000Total assets: $40,000
  2. 2. Revenues 80,000Net operating income 8,360Interest expense 360Earning before taxes 8,000Less: taxes (40%) 3,200Earning after taxes 4,800a. estimate Turkars cost of equity capital using the CAPM, assuming that the risk free is 7%, the expected returnon the market is 12% with an attendant beta of 1.66b. Determine and explain the market value of Turkars equity, price per share as well as its market value.c. What is Turkars current weighted average cost of capital (WACC), using the 10% cost of debt given earlier andthe cost of equity calculated in part (a) assume no short term interest bearing debt.d. calculate the new financial structure and coverage relationships for expansion with debt and equity assumingthat the percentage of net operating income to total assets remains the same.e. if debt financing is used, the cost of equity will rise to reflect the higher and hence a beta of 1.72. With equityfinancing, the beta will drop to 1.60 to reflect low risk. Given this, calculate and discuss the cost if equity underboth the debt and equity financing alternatives.f. calculate the market value of equity and price per share under each financing methodg. calculate and discuss the market value of Tukar under each financing optionh. calculate and discuss the WACC under each method of financing
  3. 3. 1. based upon your activities above, which form of financing would you recommend for Tukar? Why? j. In a 2 or 3 paragraphs, discuss several major pros and cons associated with debt and equity financing.Current Ratio 2Sales to Total Assets 2.1Current Debt to Total Assets 0.36Long-Term Debt to Net Worth(Equity) 0.32Total Debt to Total Assets 0.52Fixed Coverage Ratio 6Net Income to Sales 0.04Return on Total Assets (ROA) 0.09Net Income to Net Worth (Equity) 0.18 Tukar Inc., Balance Sheet December 31, 2006 (thousands of dollars)ASSETSCash 2520A/R 10520Inventories 15200TCA 28240Net Fixed Assets 11760Total Assets 40000LIABILITIESCurrent Liabilities 10000Long-term debt (10%) 3600Total Debt 13600
  4. 4. Shares outstanding 1000000Net Worth 26400Total Liabilities 40000 Tukar Inc., Income Statement December 31, 2006 (thousands of dollars)Revenues 80000Net Operating Income (EBIT) 8360Interest Expense 360Earnings before taxes 8000Less: taxes (40%) 3200Earnings after taxes (EAT) 4800Needed 6000 perEquity financing 32 shareTax rate 40%Risk-free rate 7%Expected Return on the Market 12%a) Cost of capital 26.92%b) Market value of Equity 26400 Its given on the balance sheet - the total of equity section Price Per Share 0.0264 Its Total of Equity divided by total outstanding shares The sum of market values of all the elements of capital structu Market value of Tukar 40000 i.e. equity + debt in our casec) WACC 19.81%d) Debt expansion Long-term debt (10%) 9600 Total assets 46000 Net Operating income 9614
  5. 5. Interest expense 960 Earnings before taxes 8654 Less:Taxes 3461.6 Earnings after taxes 5192.4 Equity expansion Net Worth 32400 Shares outstanding 1187500 Total assets 46000 Net Operating income 9614 Interest expense 360 Earnings before taxes 9254 Less:Taxes 3701.6 Earnings after taxes 5552.4e) Debt beta 1.72 Equity beta 1.6 Reflects the higher risk of Debt financing and therefore higher Cost of equity with new Debt 27.64% than Cost of equity Cost of equity with new Equity 26.20% with New Equity financing of expansionf) Debt Equity Market value of equity 26400 32400 Price per share 0.0264 0.027284211 It will be the same since in both cases theg) Market value of Tukar 46000 46000 amount of financing is 6000 hence it would increase the total market va by the same amount
  6. 6. The difference would be through which channel - equity or debt Debt Equity We can see from this calculations that over cost of financing with debt is lower than tha h) WACC 18.42% 20.23% of with Equity. That could be explained by the tax advanta of issuing new debt. The overall conclusion here is that the company should go with debt financingClick here for Accounting Assignment Help