Problem 16-9 Capital Structure Analysis Pettit Printing Company has a total mark
ID: 2790185 • Letter: P
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 $11.94 million, and its tax rate is 35%. 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 million should be entered as 1.2, not 1,200,000. 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 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
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
Answer:
The weighted average cost of capital is :
WACC = rD(1-T)*(D/V) + rE*(E/V)
E = Market value of the company's equity
D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
T= Tax Rate
Value of the firm = EBIT*(1-TAX RATE)/WACC
Solution:
Present situation : 50% debt
WACC= 50%* 10%*(1-35%)+50%*13%=9.75%
Value of the firm = $11.94*(1-0.35)/9.75%= 79.60milllion
75% Debt:
WACC= 75%*10%* (1-0.35)+25*13% =8.13%
Value of the firm=11.94*(1-0.35)/8.13%= 95.52 million
25%Debt:
WACC=25%*10%*(1-0.35)+75%*13%= 11.38%
Value of the firm= 11.94*(1-0.35)/11.38%= 68.23 million
Answer:
The weighted average cost of capital is :
WACC = rD(1-T)*(D/V) + rE*(E/V)
E = Market value of the company's equity
D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
T= Tax Rate
Value of the firm = EBIT*(1-TAX RATE)/WACC
Solution:
Present situation : 50% debt
WACC= 50%* 10%*(1-35%)+50%*13%=9.75%
Value of the firm = $11.94*(1-0.35)/9.75%= 79.60milllion
75% Debt:
WACC= 75%*10%* (1-0.35)+25*13% =8.13%
Value of the firm=11.94*(1-0.35)/8.13%= 95.52 million
25%Debt:
WACC=25%*10%*(1-0.35)+75%*13%= 11.38%
Value of the firm= 11.94*(1-0.35)/11.38%= 68.23 million