Question

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 $11.13 million, and its tax rate is 20%. Pettit can change its capital structure by either increasing its debt to 65% (based on market values) or decreasing it to 35%. 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 its old bonds and replace them with new 7% 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, is, is 14%. If it increases leverage, r's will be 16%. If it decreases leverage, 's will be 13%. Present situation (50% debt): What is the firm's WACC? Do not round intermediate calculations. Round your answer to three decimal places. What is the total corporate value? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to three decimal places. million 65% debt: What is the firm's WACC? Do not round Intermediate calculations. Round your answer to two decimal places What is the total corporate value? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to three decimal places. million 35% debt: What is the firm's WACC? Do not round Intermediate calculations. Round your answer to two decimal places. What is the total corporate value? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to three decimal places. million

Answer 1

50% Debt case - Tax (E Ke=14% = 20% in e Kd = 10%. WACC & Weke + Wd Kd (1-7) - (0.50) (0.14) + (0.50] (0.10) (1-0.20) 0.07 +0.04 WACC = 11% Total corporate Value it, Value of the company - Earnings Alter Tax CEAT) WACC EBIT (1-7) WALC = 19.13 (-0.20) Vo = $ 80.945 million Applying the above formula in remaining Po 2 cases

65 t Debt use - weight et equity = 1-0.65 = 0.35 ke-161 Kd=13% WACC = 6.35) (0.16) + (0.65) ( 0.13) (1-0.20) WACC = 0.056 + 0.0676 WACC = 0.1236 WALC = 12.36% value of company www = = 11.13 11.)3 (1-0.20) - 0.1236 - Vc = $ 72.038 million 3 . 3 eltھے و عاوننا ع يقسو : مزه - ركه ت | Ke = 13 t Kd = 7% WACC = (0.65) (0.13) + (0.35) (0.07) (1-0.20% - = 0.0845 +0.0196 = 0.1041 ... WACC - 10.41 %. Value of company = 11.13 (1-0.20) 0.1041 $85.533 million V =

Case 1 : debt 50%

WACC =11%

VALUE OF COMPANY Vc = $ 80.945 million.

Case 2 : debt 65%

WACC = 12.36%

Vc = $ 72.038 million.

Case3 : debt 35%

WACC = 10.41%

Vc = $ 85.533 million.