Suppose that Papa Bell, Inc.’s, equity is currently selling for $25 per share, w
ID: 2819168 • Letter: S
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.
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.)
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.
Explanation / Answer
(After a minor calculation error) (Done by the same expert)
The current capital weights are:
E = $25 x 2,000,000 = $50,000,000
D = 9000 x $1000 x 0.93 = $83,70,000
(E + D) = $58,370,000
Equity = E / E+D = 85.66%
Debt = D / E+D = 14.33%
And therefore the current D/E is 0.1433 / 0.8566 = 0.1674
Since, Papa Bell was considering an active change to its capital structure so as to have a D/E of 0.5, so they have to increase its ratio,
To do so, they would have to change their debt ratio to 0.5 /1.5 = 0.333
And this would require issuing or selling bonds and then using the proceeds to buy back stocks!
This would require issuing:
= (0.333-0.1674) x [$50,000,000 + $83,70,000]
=$9,666,072.00
Hence, $9,666,072.00 amount of bonds (of new debt) should be issued (sell) and using the proceeds to buy back the stocks.