(a) Cactus Sdn. Bhd. has no debt outstanding and a total market value of RM150,000. Earnings...

 

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(a) Cactus Sdn. Bhd. has no debt outstanding and a total market value of RM150,000. Earnings before interest and taxes, EBIT, are projected to be RM25,000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a RM45,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,500 shares outstanding and the tax rate is 35 percent. i. What will be the percentage change in Earnings Per Share (EPS) if the economy has a strong expansion? (8 marks) ii. Assume that the economic conditions are normal and the company expects its EBIT to be same every year forever. The company's cost of equity is 12 percent. What will be the value of the company if it borrows RM35,000, irrespective of previous debt, and uses the loan proceeds to repurchase shares? (6 marks) iii. Given the normal economic condition, what will be the Weighted Average Cost of Capital (WACC) after recapitalization? (7 marks) (b) Evaluate the following statement: "Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits." (4 marks) (a) Cactus Sdn. Bhd. has no debt outstanding and a total market value of RM150,000. Earnings before interest and taxes, EBIT, are projected to be RM25,000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a RM45,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,500 shares outstanding and the tax rate is 35 percent. i. What will be the percentage change in Earnings Per Share (EPS) if the economy has a strong expansion? (8 marks) ii. Assume that the economic conditions are normal and the company expects its EBIT to be same every year forever. The company's cost of equity is 12 percent. What will be the value of the company if it borrows RM35,000, irrespective of previous debt, and uses the loan proceeds to repurchase shares? (6 marks) iii. Given the normal economic condition, what will be the Weighted Average Cost of Capital (WACC) after recapitalization? (7 marks) (b) Evaluate the following statement: "Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits." (4 marks)

Answer rating: 100% (QA)

a i Percentage change in Earnings Per Share EPS if the economy has a strong expansion Given information Total market value of Cactus Sdn Bhd RM150000 Earnings Before Interest and Taxes EBIT under norm... View the full answer