Purchase Solution

Recapitalization

Not what you're looking for?

Ask Custom Question

1. Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?

1.25%
1.91%
2.23%
2.64%
2.86%

2. The firm's target capital structure is consistent with which of the following?

Maximum earnings per share (EPS).
Minimum cost of debt (rd).
Highest bond rating.
Minimum cost of equity (rs).
Minimum weighted average cost of capital (WACC).

3. Jones Co. currently is 100% equity financed. The company is considering changing its capital structure. More specifically, Jones' CFO is considering a recapitalization plan in which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets nor would it affect the company's basic earning power, which is currently 15%. The CFO estimates that the recapitalization will reduce the company's WACC and increase its stock price. Which of the following is also likely to occur if the company goes ahead with the planned recapitalization?

The company's net income will increase.
The company's earnings per share will decrease.
The company's cost of equity will increase.
The company's ROA will increase.
The company's ROE will decrease.

4. Tapley Inc. currently has assets of $5 million, zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $1 million, and pays out 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5 percent per year, 200,000 shares of stock are outstanding, and the current WACC is 13.40%.The company is considering a recapitalization where it will issue $1 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, its before-tax cost of debt will be 11%, and its cost of equity will rise to 14.5%.

What is the stock's current price per share (before the recapitalization)?

Assuming the company maintains the same payout ratio, what will be its stock price following the recapitalization?

Purchase this Solution

Solution Summary

The solution has various questions relating to recapitalization

Solution Preview

Please see the attached file for answers/explanations in blue

1. Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?

1.25%
1.91%
2.23% X
2.64%
2.86%

A B
Total assets 2,000,000 2,000,000
Debt 1,000,000 600,000
EBIT 400,000 400,000
Interest 120,000 60,000
EBT 280,000 340,000
Tax (40%) 112,000 136,000
Net Income 168,000 204,000
Equity 1,000,000 1,400,000
ROE 16.8% 14.57%
Difference 2.23%

2. The firm's target capital structure is consistent with which of the following?

Maximum earnings per share (EPS).
Minimum cost of debt (rd).
Highest bond rating.
Minimum cost of equity (rs).
Minimum weighted average cost of capital (WACC). X

This is ...

Purchase this Solution


Free BrainMass Quizzes
Writing Business Plans

This quiz will test your understanding of how to write good business plans, the usual components of a good plan, purposes, terms, and writing style tips.

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.

Cost Concepts: Analyzing Costs in Managerial Accounting

This quiz gives students the opportunity to assess their knowledge of cost concepts used in managerial accounting such as opportunity costs, marginal costs, relevant costs and the benefits and relationships that derive from them.

Organizational Behavior (OB)

The organizational behavior (OB) quiz will help you better understand organizational behavior through the lens of managers including workforce diversity.

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