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 $10.12 million, and its tax rate is 15%. Pettit can change its capital structure either by increasing its debt to 75% (based on market values) or decreasing it to 25%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 13% 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%. 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 miion should be entered as 1.2, not 1,200000. Round your answer to three decimal places. million 75% debt: What is the firm's WACC? Round your answer to two decimal places What is the total corporate value? Enter your answer in mllions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,0. Round your answer to three decimal places. million 25% 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

When bond is selling at par, coupon rate equals yield. In such case, cost of debt = yield = coupon rate

With 50% debt:

Value of common stock = $50 million

Value of debt = $50 million

wd = 50%, we = 50%

WACC = 0.5*10*(1 – 0.15) + 0.5*14 = 11.25%

EBIT = $10.12 million

CF = 10.12*(1 – 0.15)

Corporate value = 10.12*(1 – 0.15)/0.1125 = $76.462 million

With 75% debt:

WACC = 0.75*13*(1 – 0.15) + 0.25*16 = 12.2875%

Corporate value = 10.12*(1 – 0.15)/0.122875 = $70.006 million

With 25% debt:

WACC = 0.25*8*(1 – 0.15) + 0.75*13 = 11.45%

Corporate value = 10.12*(1 – 0.15)/0.1145 = $75.127 million

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