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Capital Structure Analysis
Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company’s EBIT is $13.24 million, and its tax rate is 15%. Pettit can change its capital structure by either increasing its debt to 70% (based on market values) or decreasing it to 30%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 8% coupon bonds. The company will sell or repurchase stock at the new
The firm pays out all earnings as dividends; hence, its stock is a zero-growth stock. Its current
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Intermediate Financial Management (MindTap Course List)
- Hasting Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.4 (given its target capital structure). Vandell has $10.82 million in debt that trades at par and pays an 8% interest rate. Vandell’s free cash flow (FCFJ is $2 million per year and is expected to grow at a constant rate of 5% a year. Vandell pays a 40% combined federal and state tax rate. The risk-free rate of interest is 5%, and the market risk premium is 6%. Hasting’s First step is to estimate the current intrinsic value of Vandell. What are Vandell’s cost of equity and weighted average cost of capital? What is Vandell’s intrinsic value of operations? [Hint: Use the free cash flow corporate valuation model from Chapter 8.) What is the current intrinsic value of Vandell’s stock?arrow_forwardOptimal Capital Structure with Hamada Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero-growth firm and pays out all of its earnings as dividends. The firm’s EBIT is $14,933 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.0. What is BEA’s unlevered beta? Use market value D/S (which is the same as wd/ws when unlevering. What are BEA’s new beta and cost of equity if it has 40% debt? What are BEA’s WACC and total value of the firm with 40% debt?arrow_forwardHasting Corporation is interested in acquiring Vandell Corporation. Vandell has 1.5 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.4 (given its target capital structure). Vandell has $10.19 million in debt that trades at par and pays an 8% interest rate. Vandell’s current free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year. Vandell pays a 25% combined federal-plus-state tax rate, the same rate paid by Hastings. The risk-free rate of interest is 5%, and the market risk premium is 6%. Hasting’s first step is to estimate the current intrinsic value of Vandell. What is Vandell’s cost of equity? What is its weighted average cost of capital? What is Vandell’s intrinsic value of operations? (Hint: Use the free cash flow corporate valuation model from Chapter 7.) Based on this analysis, what is the minimum stock price that Vandell’s shareholders should accept?arrow_forward
- Optimal Capital Structure with HamadaBeckman Engineering and Associates (BEA) is considering a change in itscapital structure. BEA currently has $20 million in debt carrying a rate of8%, and its stock price is $40 per share with 2 million shares outstanding.BEA is a zero-growth firm and pays out all of its earnings as dividends.The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-statetax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEAis considering increasing its debt level to a capital structure with 40% debt,based on market values, and repurchasing shares with the extra money thatit borrows. BEA will have to retire the old debt in order to issue new debt,and the rate on the new debt will be 9%. BEA has a beta of 1.0.a. What is BEA’s unlevered beta? Use market value D/S (which is the sameas wd/ws) when unlevering.b. What are BEA’s new beta and cost of equity if it has 40% debt?c. What are BEA’s WACC and total value of the firm with 40% debt?arrow_forwardPettit Printing Company (PPC) has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $12.68 million, and its tax rate is 15%. Pettit can change its capital structure by either increasing its debt to 65% (based on market values) or decreasing it to 35%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 9% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. PPC expects no growth in its EBIT, so gL is zero. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%. What is the firm's WACC and total corporate value under each capital structure? Do not round intermediate…arrow_forwardPettit Printing Company (PPC) has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $10.50 million, and its tax rate is 15%. Pettit can change its capital structure by either increasing its debt to 55% (based on market values) or decreasing it to 45%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 8% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. PPC expects no growth in its EBIT, so gL is zero. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%. What is the firm's WACC and total corporate value under each capital structure? Do not round intermediate…arrow_forward
- Assume Tiger Corporation needs to raise in capital so it can expand its operational activities. Company issues and sells 33,000 shares of stock at $13 each to raise the money which expect to provide a return of 5.8%. Furthermore, they sell 33,000 bonds for $50 each to raise the other in capital with expected rate of return of 9.5% where tax rate is 15%. What would be the effect of this financing on WACC if industry average is 5%?.arrow_forwardConsider a firm with an EBITDA of $1,100,000 and an EBIT of $1,000,000. The firm finances its assets with $4,530,000 debt (costing 8.2 percent, all of which is tax deductible) and 202,000 shares of stock selling at $11 per share. To reduce risk associated with this financial leverage, the firm is considering reducing its debt by $2,530,000 by selling additional shares of stock. The firm’s tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $1,000,000.Calculate the EPS before and after the change in capital structure and indicate changes in EPS. (Do not round intermediate calculations. Round your answers to 2 decimal places.)arrow_forwardDuke Inc. is considering to change its capital structure of a $1 million:$3 million debt-equity mix (in terms of market values), by taking out a $3 million loan which is used to pay a large dividend to shareholders. The firm’s tax rate is 40%. After the dividend has been paid, what will be the firm’s total equity value?arrow_forward
- A proposed recapitalization plan for Focus Corporation would change its current all-equity capital structure to leveraged capital structure. The proposal is for Focus to sell $47,000,000 worth of long-term debt at an interest rate of 6.5% and then repurchase as many shares as possible at a price of $28 per share. Focus currently has 4,800,000 shares outstanding and expects EBIT to be $27,000,000per year in perpetuity. Ignoring taxes, calculate the following: a. The number of shares outstanding, the per-share price, and the debt-to-equity ratio for Focus if it adopts the proposed recapitalization. b. The earnings per share (EPS) and the return on equity (ROE) for Focus under the current and proposed capital structures. c. The EBIT where EPS is the same for both capital structures. d. The EBIT where EPS is zero for both capital structures a) The number of shares outstanding for Focus if adopts the proposed recapitalization is _3,121,429_ shares. (round to the nearest…arrow_forwardConsider a firm with an EBITDA of $900,000 and an EBIT of $800,000. The firm finances its assets with $4,610,000 debt (costing 7.1 percent, all of which is tax deductible) and 211,000 shares of stock selling at $15 per share. To reduce risk associated with this financial leverage, the firm is considering reducing its debt by $2,610,000 by selling additional shares of stock. The firm’s tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $800,000. Calculate the EPS before and after the change in capital structure and indicate changes in EPS. Note: Do not round intermediate calculations. Round your answers to 2 decimal places.arrow_forwardConsider a firm with an EBITDA of $900,000 and an EBIT of $800,000. The firm finances its assets with $4,610,000 debt (costing 7.1 percent, all of which is tax deductible) and 211,000 shares of stock selling at $15 per share. To reduce risk associated with this financial leverage, the firm is considering reducing its debt by $2,610,000 by selling additional shares of stock. The firm’s tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $800,000.arrow_forward
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