Suppose that Papa Bell, Inc.’s, equity is currently selling for $25 per share, w

Question

Suppose that Papa Bell, Inc.’s, equity is currently selling for $25 per share, with 2.0 million shares outstanding. The firm also has 9,000 bonds outstanding, which are selling at 93 percent of par. Assume Papa Bell was considering an active change to its capital structure so as to have a D/E of 0.5. Which type of security (stocks or bonds) would the firm need to sell to accomplish this? Sell bonds and buy back stock Sell stock and buy back bonds How much would it have to sell? (Enter your answer in dollars not in millions. Do not round intermediate calculations and round your final answer to 2 decimal places.) Selling amount $

Explanation / Answer

Papa Bell assume to have the Debt Equity ratio of 0.5.

Market value of equity = 20,000,000*25 = 500,000,000

Value of bonds = 9000 * 1000 = 9,000,000 (Assume bonds face value is 1000)

So, Current DE ratio = Debt/Equity

= 9,000,000/500,000,000

= 0.018

So, to make the DE ratio to 0.5,

Papa Bell need to make the Bonds upto $250,000,000 or reduce equity to $18,000,000

So, they either need to:-

1) Issue Bonds of $241,000,000

2) Buy Back equity by $482,000,000

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