Question

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 $10.10 million, and its tax rate is 35%. Pettit can change its capital structure either by increasing its debt to 70% (based on market values) or decreasing it to 30%. 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, r_s, is 14%. If it increases leverage, r_s will be 16%. If it decreases leverage, r_s 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

70% 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

30% 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

Answer 1

At 50% Debt: WACC 10.25% -10%*(1-35%)*50%+14%*50% Total corporate value $ 64.0 =10.1*(1-35%)/10.25% At 70% Debt: WACC Total corporate value 10.72% -13%*(1-35%)*70%+16%*30% 61.2 -10.1*(1-35%)/10.72% $ At 30% Debt: WACC 10.66% -8%*(1-35%)*30%+13%*70% Total corporate value $ 61.6 =10.1*(1-35%)/10.66%

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