1 Calculate the value of equity after the new debt issue if KT decides to buy back stocks with the new debt issue. Assume KT does not have any short-term investments.

2 Determine how the expected decrease in sales volatility next year will affect the company’s business risk.

3 Calculate the expected value, standard deviation, and the coefficients of variation of KT’s current sales and ROE with 30 percent financial leverage. Evaluate the effect of using 30 percent financial leverage on the company’s current total risk.

4 Calculate the expected value, standard deviation, and the coefficients of variation of next year’s sales forecast and ROE with 30 percent financial leverage. Evaluate the effect of using 30 percent financial leverage on the company’s total risk next year.

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CASE DESCRIPTION: Business risk and financial risk are among the most important concepts in corporate finance. The total risk of a corporation is the sum of its business risk and financial risk. Business risk is the risk of the corporation before the financing decision. It is the risk inherent in the corporation's future operating income. An important cause of business risk is sales volatility. Financial risk is the added risk caused by dehi financing. Using financial leverage increases the total risk of the firm by increasing the volatility of a corporation's net income and return on equity. The case provides an opportunity for students to understand the determinants of business risk, financial risk, and market value in a real- world setting. Kappa Television (KT) is a television retailer in California with a high sales volatility and business risk due to competition. The company is considering the effect of increasing financial leverage on its return on equity and common stock value. CASE INFORMATION: Kappa Television (KT) Inc., is a midsize retailer of television sets in California with several stores in Los Angeles, San Francisco, and San Diego. Johnson is the founder and CEO of the company who has an electrical engineering degree from Princeton University. He always wanted to run a company. Soon after he received his degree from Princeton, he opened the first KT store in Los Angeles with some seed money from his parents and friends in 1990. The business was booming because there was an increasing demand for high definition television sets in the United States. Many people were getting rid of their old television sets and replacing them with new technology LCD or plasma television sets. The company enjoyed a high growth rate during its first few years. Ian Johnson took the company public with a successful initial public offering in 1995. The company paid no dividends and reinvested all of its earnings during the high growth years in the 1990s. The investors were happy with the capital gain the company's stock was providing and they did not mind not receiving any dividends from the company. Ilowever, when the growth rate began to slow down at the turn of the century, the company had to start paying out some dividends with the pressure from the shareholders. The company has had no net growth during the last couple of years because many people have already replaced their old television sets with a new technology set. This has forced the company to start distributing all of its net income as dividends to shareholders. The business continues to be profitable, however, and the shareholders are happy to receive a substantial amount of dividend from the company every year. Generous dividend payments have helped the market price of the company's stock to remain at a reasonably high level. However, an important problem causing volatility in KT's sales and stock price has been television set imports with unknown brand names from phantom television set manufacturers in the Far East. These manufacturers would flood the market with cheap and low quality television sets from time to time causing KT's sales and revenues to drop. Although many customers would prefer to buy quality television sets with well- known brand names, some people could not resist the low prices of the low quality television sets with unknown brand names. These phantom television set manufacturers would often stop their operations abruptly and they would disappear from the market for several years. In those years, KT would enjoy high levels of sales with good revenues. Sales Volatility and Business Risk Ian Johnson realized the volatility of KT's sales was adversely affecting the company's business risk and stock price. Therefore, he decided the company should conduct a study to determine the effects. At the beginning of the year, KT hired Nancy Smart, who is a recent graduate of the Wharton MBA Program, as the head of the company's newly established CASE DESCRIPTION: Business risk and financial risk are among the most important concepts in corporate finance. The total risk of a corporation is the sum of its business risk and financial risk. Business risk is the risk of the corporation before the financing decision. It is the risk inherent in the corporation's future operating income. An important cause of business risk is sales volatility. Financial risk is the added risk caused by dehi financing. Using financial leverage increases the total risk of the firm by increasing the volatility of a corporation's net income and return on equity. The case provides an opportunity for students to understand the determinants of business risk, financial risk, and market value in a real- world setting. Kappa Television (KT) is a television retailer in California with a high sales volatility and business risk due to competition. The company is considering the effect of increasing financial leverage on its return on equity and common stock value. CASE INFORMATION: Kappa Television (KT) Inc., is a midsize retailer of television sets in California with several stores in Los Angeles, San Francisco, and San Diego. Johnson is the founder and CEO of the company who has an electrical engineering degree from Princeton University. He always wanted to run a company. Soon after he received his degree from Princeton, he opened the first KT store in Los Angeles with some seed money from his parents and friends in 1990. The business was booming because there was an increasing demand for high definition television sets in the United States. Many people were getting rid of their old television sets and replacing them with new technology LCD or plasma television sets. The company enjoyed a high growth rate during its first few years. Ian Johnson took the company public with a successful initial public offering in 1995. The company paid no dividends and reinvested all of its earnings during the high growth years in the 1990s. The investors were happy with the capital gain the company's stock was providing and they did not mind not receiving any dividends from the company. Ilowever, when the growth rate began to slow down at the turn of the century, the company had to start paying out some dividends with the pressure from the shareholders. The company has had no net growth during the last couple of years because many people have already replaced their old television sets with a new technology set. This has forced the company to start distributing all of its net income as dividends to shareholders. The business continues to be profitable, however, and the shareholders are happy to receive a substantial amount of dividend from the company every year. Generous dividend payments have helped the market price of the company's stock to remain at a reasonably high level. However, an important problem causing volatility in KT's sales and stock price has been television set imports with unknown brand names from phantom television set manufacturers in the Far East. These manufacturers would flood the market with cheap and low quality television sets from time to time causing KT's sales and revenues to drop. Although many customers would prefer to buy quality television sets with well- known brand names, some people could not resist the low prices of the low quality television sets with unknown brand names. These phantom television set manufacturers would often stop their operations abruptly and they would disappear from the market for several years. In those years, KT would enjoy high levels of sales with good revenues. Sales Volatility and Business Risk Ian Johnson realized the volatility of KT's sales was adversely affecting the company's business risk and stock price. Therefore, he decided the company should conduct a study to determine the effects. At the beginning of the year, KT hired Nancy Smart, who is a recent graduate of the Wharton MBA Program, as the head of the company's newly established

Answer rating: 100% (QA)

Answer 1 The value of equity after the new debt issue depends on how much of the new debt is used to buy back stocks and the amount of the new debt issue The formula for calculating equity value is Eq... View the full answer