Question: As Chief Financial Officer of the Magnificent Electronics Corporation MEC
As Chief Financial Officer of the Magnificent Electronics Corporation (MEC), you are considering a recapitalization plan that would convert MEC from its current all-equity capital structure to one including substantial financial leverage. DIC now has 500,000 shares of common stock outstanding, which are selling for $60 each, and you expect the firm’s EBIT to be $2,400,000 per year for the foreseeable future. The recapitalization proposal is to issue $15,000,000 worth of long-term debt at an interest rate of 6.0 percent and use the proceeds to repurchase 250,000 shares of common stock worth $15,000,000. Assuming there are no market frictions such as corporate or personal income taxes, calculate the expected return on equity for MEC shareholders under both the current all-equity capital structure and under the recapitalization plan.
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