Thorndike Oil (TO) is a diversified company with two operating divisions: Oil and Telecom which represent 70%
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Question:
a. Estimate the expected return on TO’s equity.
Now assume that TO is considering a change in its capital structure that will increase its leverage. Two plans are considered:
1. Issue $55 million immediately in debt and maintain its level in perpetuity.
2. Issue $90 million immediately in debt, repay $20 million of its principal in one year, $20 million in two years and maintaining the remaining $50 million in perpetuity. Assume that in both plans TO will be able to borrow at the risk-free interest rate; that all proceeds are paid out to equity holders and that in Plan 2 the reduction in debt is financed by issuing equity. Corporate tax rate is 35% and there are no other markets imperfections.
b. Which of these two plans would you recommend? Explain.
Related Book For
Intermediate Accounting
ISBN: 978-0132162302
1st edition
Authors: Elizabeth A. Gordon, Jana S. Raedy, Alexander J. Sannella
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