Problem 15-9 Capital Structure Analysis Pettit Printing Company has a total mark
ID: 2623270 • Letter: P
Question
Problem 15-9
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 $13.12 million, and its tax rate is 20%. Pettit can change its capital structure either by 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 in 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.
The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%.
**Please Round Answers Accordingly**
Present situation (50% debt):
What is the firm's WACC? Round your answer to three decimal places.
%
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million
70% debt:
What is the firm's WACC? Round your answer to two decimal places.
? %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million
30% debt:
What is the firm's WACC? Round your answer to two decimal places.
? %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million
Explanation / Answer
A
DEBENTURES:
Pre-Tax Cost of Debt = 10%
After-Tax Cost of Debt = 10*(1-20%) = 8%
Market Value of Debt = $50M
COMMON STOCK
Cost of Equity = 14%
Market Value of Common Stock = $100M
WACC = Proportion of each fund * Cost of fund
[50M/(50M + 100M)]*8% + [100M/(50M + 100M)]*14%
= 12%
PARTICULARS
AMOUNT
EBIT
13120000
(-) Interest
5000000
EBT
8120000
(-) Tax @ 20%
1624000
Net Income [i]
6496000
Cost of Equity [ii]
14%
Value of Equity [iii = i/ii]
46400000.00
Value of Debt [iv]
50000000
Total Value of Firm [iii + iv]
96400000.00
Corporate Value = $96.400M
B
DEBENTURES:
Pre-Tax Cost of Debt = 12%
After-Tax Cost of Debt = 12*(1-20%) = 9.6%
Debt proportion = 0.7
Market Value of Debt = 0.7*Total Market Value of funds
=0.7*(50M + 150M) = $105M
COMMON STOCK
Cost of Equity = 16%
Equity proportion = 0.3
Market Value of Equity = 0.3*Total Market Value of funds
=0.3*(50M + 150M) = $45M
WACC = Proportion of each fund * Cost of fund
= 0.7*9.6% + 0.3*16%
= 11.52%
PARTICULARS
AMOUNT
EBIT
13120000
(-) Interest
12600000
EBT
520000
(-) Tax @ 20%
104000
Net Income [i]
416000
Cost of Equity [ii]
16.00%
Value of Equity [iii = i/ii]
2600000.00
Value of Debt [iv]
105000000
Total Value of Firm [iii + iv]
107600000.00
Corporate Value = $107.600M
C
DEBENTURES:
Pre-Tax Cost of Debt = 8%
After-Tax Cost of Debt = 12*(1-20%) = 6.4%
Debt proportion = 0.3
Market Value of Debt = 0.3*Total Market Value of funds
=0.3*(50M + 150M) = $45M
COMMON STOCK
Cost of Equity = 13%
Equity proportion = 0.7
Market Value of Debt = 0.7*Total Market Value of funds
=0.7*(50M + 150M) = $105M
WACC = Proportion of each fund * Cost of fund
= 0.3*6.4% + 0.7*13%
= 11.02%
PARTICULARS
AMOUNT
EBIT
13120000
(-) Interest
3600000
EBT
9520000
(-) Tax @ 20%
1904000
Net Income [i]
7616000
Cost of Equity [ii]
13%
Value of Equity [iii = i/ii]
58584615.38
Value of Debt [iv]
45000000
Total Value of Firm [iii + iv]
103584615.38
Corporate Value = $103.585M
PARTICULARS
AMOUNT
EBIT
13120000
(-) Interest
5000000
EBT
8120000
(-) Tax @ 20%
1624000
Net Income [i]
6496000
Cost of Equity [ii]
14%
Value of Equity [iii = i/ii]
46400000.00
Value of Debt [iv]
50000000
Total Value of Firm [iii + iv]
96400000.00