Analysis of FCS Inc Corporate Bond

  Analysis of FCS Inc Corporate Bond In this analysis, we will compute the necessary financial ratios for FCS Inc. to determine its bond rating, calculate the weighted average cost of capital (WACC), and find the implied growth rate for the free cash flow to the firm (FCFF). a) Ratio Computation for Bond Rating Given Financial Data Balance Sheet (in thousands): - Current Assets: $4,735 - Fixed Assets: $43,225 - Total Assets: $47,960 - Current Liabilities: $4,500 - Long-term Debt: $10,000 - Total Liabilities: $14,500 - Shareholder Equity: $33,460 Income Statement (in thousands): - Revenue: $18,500 - Operating and Admin. Expenses: $14,050 - Operating Income before D&A: $4,450 - Depreciation & Amortization: $1,675 - Interest Expense: $942 - EBT: $1,833 - Taxes: $641 - Net Income: $1,192 Ratios Calculation 1. Interest Coverage Ratio (ICR): [ \text{ICR} = \frac{\text{EBITDA}}{\text{Interest Expense}} ] - EBITDA = Operating Income + Depreciation & Amortization - EBITDA = (4,450 + 1,675 = 6,125) - ICR = (\frac{6,125}{942} \approx 6.50) 2. Leverage Ratio: [ \text{Leverage} = \frac{\text{Long-term Debt}}{\text{Shareholder Equity}} ] - Leverage = (\frac{10,000}{33,460} \approx 0.298) 3. Current Ratio: [ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} ] - Current Ratio = (\frac{4,735}{4,500} \approx 1.05) Summary of Ratios - Interest Coverage Ratio (ICR): 6.50 - Leverage Ratio: 0.298 - Current Ratio: 1.05 Bond Rating Determination Using the provided rating table: Bond Rating Interest Coverage Leverage Current Ratio Risk Premium AA 5.0 to 6.0 0.25 to 0.30 1.15 to 1.25 0.30% A 4.0 to 5.0 0.30 to 0.40 1.00 to 1.15 0.50% BBB 3.0 to 4.0 0.40 to 0.50 0.90 to 1.10 1.00% BB 2.0 to 3.0 0.50 to 0.60 0.75 to 0.90 1.25% Based on the calculated ratios: - ICR of 6.50 fits within the AA range. - Leverage of 0.298 also fits within the AA range. - Current Ratio of 1.05 is below the AA range but within the A range. Thus, FCS Inc's bond rating should be classified as AA based on its stronger interest coverage and leverage ratios. b) Weighted Average Cost of Capital (WACC) Calculation Given Data - Risk-Free Rate (Rf): 3% - Market Risk Premium (MRP): 6% - Beta (β): 1.20 - Tax Rate: 25% - Market Debt Ratio (MDR): 0.40 Cost of Equity Calculation Using the Capital Asset Pricing Model (CAPM): [ \text{Cost of Equity} = R_f + \beta \times (MRP) ] [ \text{Cost of Equity} = 3% + 1.20 \times 6% = 3% + 7.2% = 10.2% ] Cost of Debt Calculation The cost of debt before tax is given by the bond’s risk premium: [ \text{Cost of Debt} = \text{Risk Premium} + R_f = 0.55% + 3% = 3.55% ] After tax adjustment: [ \text{After-tax Cost of Debt} = \text{Cost of Debt} \times (1 - \text{Tax Rate}) = 3.55% \times (1 - 0.25) = 3.55% \times 0.75 = 2.6625% ] WACC Calculation Assuming Total Debt and Market Value of Equity can be derived based on MDR: - Let ( D ) be total debt ($10,000 long-term debt and $1,500 short-term debt) resulting in total debt ( D + E = D / MDR ) - Total Debt = ( D = $14,500 * MDR = $14,500 * 0.40 = $5,800 ) - Equity Value ( E = Total Assets - Total Debt = $47,960 - $10,000 = $33,460 ) Calculating WACC: [ WACC = \left( \frac{E}{D + E} \times \text{Cost of Equity} \right) + \left( \frac{D}{D + E} \times \text{After-tax Cost of Debt} \right) ] Where: - ( D + E = $14,500 + $33,460 = $47,960 ) - ( E / (D + E) = 33,460 / 47,960 \approx 0.6975 ) - ( D / (D + E) = 14,500 / 47,960 \approx 0.3025 ) Substituting values into WACC formula: [ WACC = (0.6975) \times (10.2%) + (0.3025) \times (2.6625%) ] Calculating: [ WACC \approx (0.07115) + (0.00806) = 7.22% ] c) Implied Growth Rate for Free Cash Flow to the Firm (FCFF) Given Information - Capital Expenditures (CapEx) are (1.12x) Depreciation. - Change in Net Working Capital is zero. FCFF Calculation FCFF can be calculated using the formula: [ FCFF = EBIT(1 - Tax Rate) + Depreciation - CapEx ] Where: - EBIT: (EBT + Interest Expense = $1,833 + $942 = $2,775) Calculating FCFF: 1. After-tax EBIT: [ EBIT(1 - Tax Rate) = $2,775(1 - 0.25) = $2,775 * 0.75 = $2,081.25 ] 2. CapEx calculation: - CapEx (= Depreciation * 1.12 = $1,675 * 1.12 = $1,875) 3. Therefore, [ FCFF = $2,081.25 + $1,675 - $1,875 ] Simplifying, [ FCFF = $2,081.25 + $1,675 - $1,875 = $1,881.25 ] Implied Growth Rate Calculation To find the implied growth rate (g), we can use the Gordon Growth Model: If FCFF is expected to grow at a constant rate post-stability, Assuming a stable growth rate model: [ g = Capital Expenditures - Depreciation ] Since CapEx is based on depreciation, By setting (g) in terms of depreciation, We know that growth is tied directly to reinvestment in assets. Thus, Assuming stable conditions and long-run growth, The implied growth rate for FCFF is approximated as consistent with CapEx levels: Given zero change in working capital and stable reinvestment, If depreciation rates are consistent over time with reinvestment patterns, This implies a stable moderate growth rate based on asset management. Final answer for implied growth rate cannot be precisely calculated without future cash flow projections or market conditions considerations but remains tied directly to capital expenditure rates vs depreciation over the long term. This comprehensive analysis serves as a guideline for assessing FCS Inc.’s bond rating and investment viability while estimating WACC and growth metrics essential for making informed financial decisions.  

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