Problem 15-9 Capital Structure Analysis Pettit Printing Company has a total mark
ID: 2724086 • 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 $11.06 million, and its tax rate is 25%. Pettit can change its capital structure either by 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 in its old bonds and replace them with new 7% 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%.
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
55% debt:
What is the firm's WACC? Round your answer to two decimal places.
{C} %
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
45% debt:
What is the firm's WACC? Round your answer to two decimal places.
{C} %
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
Present situation (50% debt):
firm's WACC=14%*(0.50)+0.50*10%*(1-0.25)=10.750%
total corporate value=EBIT(1-taxrate)/Wacc=$11.06*(1-0.25)/0.1075=77.163 millions
55% debt:
cost of debt=12%
firm's WACC=16%*(0.45)+0.55*12%*(1-0.25)=12.150%
total corporate value=EBIT(1-taxrate)/Wacc=$11.06*(1-0.25)/0.1215=68.272 millions
45% debt:
cost of debt=7% firm's
WACC=13%*(0.55)+0.45*7%*(1-0.25)=9.5125%=9.51%
total corporate value=EBIT(1-taxrate)/Wacc=$11.06*(1-0.25)/0.095125=87.201 millions