Problem 16-9 Capital Structure Analysis Pettit Printing Company has a total mark

Question

Problem 16-9 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 $12.54 million, and its tax rate is 35%, Pettit can change its capital structure either by increasing its debt to 60% (based on market values) or decreasing it to 40%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 14% 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 149 . If t 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 60% 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 40% 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

Case 1: with 50% debt

WACC = 0.5*10*(1 – 0.35) + 0.5*14 = 10.25%

CF = 12.54*(1 – 0.35)

Firm’s value = 12.54*(1 – 0.35)/0.1025 = 79.52195122

Case 2: with 60% debt

WACC = 0.6*14*(1 – 0.35) + 0.4*16 = 11.86%

Firm’s value = 12.54*(1 – 0.35)/0.1186 = 68.726813

Case 2: with 40% debt

WACC = 0.4*8*(1 – 0.35) + 0.6*13 = 9.88%

Firm’s value = 12.54*(1 – 0.35)/0.0988 = 82.50

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