Company has an all equity capital structure. Financial position is as follows: Assets (book market) EBIT...

 

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Company has an all equity capital structure. Financial position is as follows: Assets (book market) EBIT Cost of Equity r's Stock Price Po Shares outstanding no Tax Rate 2,000,000 400,000 11% $20 100,000 34% The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure of 30% debt based on market values, its cost of equity (rs) will increase to 13% to reflect increased risk. Bonds can be sold at a cost (rd) of 9%. The company is no growth hence all earnings are paid out as dividends and earnings are expected to be constant over time. (a) What is the new value of the firm after it increases debt? (b) What would be the new price of the stock? (c) What happens to the firm's earnings per share (EPS) after the recapitalization? (d) Now assume capital structure of 50% debt based on market values. Cost of equity increase to 14% and bonds can be sold at cost of 11%. Answer (a-c). Company has an all equity capital structure. Financial position is as follows: Assets (book market) EBIT Cost of Equity r's Stock Price Po Shares outstanding no Tax Rate 2,000,000 400,000 11% $20 100,000 34% The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure of 30% debt based on market values, its cost of equity (rs) will increase to 13% to reflect increased risk. Bonds can be sold at a cost (rd) of 9%. The company is no growth hence all earnings are paid out as dividends and earnings are expected to be constant over time. (a) What is the new value of the firm after it increases debt? (b) What would be the new price of the stock? (c) What happens to the firm's earnings per share (EPS) after the recapitalization? (d) Now assume capital structure of 50% debt based on market values. Cost of equity increase to 14% and bonds can be sold at cost of 11%. Answer (a-c).