Recapitalization and Capitalzation Decisions
Not what you're looking for?
PLEASE SOLVE FINANCIAL MANAGEMENT PROBLEM AS PER ATTACHED FILE
Purchase this Solution
Solution Summary
1. A consultant has collected the following information regarding Young Publishing:
Total assets $3,000 million Tax rate 40%
Operating income (EBIT) $800 million Debt ratio 0%
Interest expense $0 million WACC 10%
Net income $480 million M/B ratio 1.00×
Share price $32.00 EPS = DPS $3.20
The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). Young's stock price can be calculated by simply dividing earnings per share by the required return on equity capital, which currently equals the WACC because the company has no debt.
The consultant believes that the company would be much better off if it were to change its capital structure to 40 percent debt and 60 percent equity. After meeting with investment bankers, the consultant concludes that the company could issue $1,200 million of debt at a before-tax cost of 7 percent, leaving the company with interest expense of $84 million. The $1,200 million raised from the debt issue would be used to repurchase stock at $32 per share. The repurchase will have no effect on the firm's EBIT; however, after the repurchase, the cost of equity will increase to 11 percent. If the firm follows the consultant's advice, what will be its estimated stock price after the capital structure change?
2. A growing company is confronted with a choice between 15% debt issues and equity issues to finance its new investments. The firm's pre-expansion income statement is as follows:
Amount in $
Sales (production capacity of $6,000,000 at current sales price) 4,500,000
Fixed cost 500,000
Variable cost (66 2/3%) 3,000,000
EBIT 1,000,000
Interest at 12.5% 100,000
Earnings before taxes 900,000
Income tax (at 50%) 450,000
Net income 450,000
Earnings per share (EPS) 9
The expansion program is estimated to cost $500,000. If this is financed through debt, the rate on new debt will be 15% and the P/E ratio will be 10 times. If expansion program is financed through equity, new shares can be sold at $100 per share, and the P/E ratio will be 12 times. Expansion will generate additional sales of $1,275,000. No additional fixed costs would be needed to meet the expansion operation. If the company is to follow a policy of maximizing the market value of its shares, which form of financing should be employed by the company?
Purchase this Solution
Free BrainMass Quizzes
Managing the Older Worker
This quiz will let you know some of the basics of dealing with older workers. This is increasingly important for managers and human resource workers as many countries are facing an increase in older people in the workforce
Business Ethics Awareness Strategy
This quiz is designed to assess your current ability for determining the characteristics of ethical behavior. It is essential that leaders, managers, and employees are able to distinguish between positive and negative ethical behavior. The quicker you assess a person's ethical tendency, the awareness empowers you to develop a strategy on how to interact with them.
Team Development Strategies
This quiz will assess your knowledge of team-building processes, learning styles, and leadership methods. Team development is essential to creating and maintaining high performing teams.
Introduction to Finance
This quiz test introductory finance topics.
Motivation
This tests some key elements of major motivation theories.