Gentry Motors Inc., a producer of turbine generators, is in this situation: EBIT$4 million, tax rateT35%, debt
Question:
Gentry Motors Inc., a producer of turbine generators, is in this situation: EBIT¼$4 million, tax rate¼T¼35%, debt outstanding¼D¼$2 million, rd¼10%, rs¼15%, shares of stock outstanding¼N0¼600,000, and book value per share¼$10.Because Gentry’s product market is stable and the company expects no growth, all earnings are paid out as dividends. The debt consists of perpetual bonds
.a.What are Gentry’s earnings per share (EPS) and its price per share (P0)?
b.What is Gentry’s weighted average cost of capital (WACC)?
c.Gentry can increase its debt by $8 million to a total of $10 million, using the new debt to buy back and retire some of its shares at the current price. Its interest rate on debtwill be 12% (it will have to call and refund the old debt), and its cost of equity will rise from 15% to 17%. EBIT will remain constant. Should Gentry change its capital structure? Why or why not?
d.If Gentry did not have to refund the $2 million of old debt, how would this affectthe situation? Assume that the new and the still outstanding debt are equally risky, with rd¼12%, but that the coupon rate on the old debt is 10%
Introduction to Financial Accounting
ISBN: 978-0133251036
11th edition
Authors: Charles Horngren, Gary Sundem, John Elliott, Donna Philbrick