Kris Corporation is a leading automobile manufacturer. The balance sheet of the company is as follows...
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Kris Corporation is a leading automobile manufacturer. The balance sheet of the company is as follows (in millions): Assets Fixed Assets Current Assets 4000 1000 . Liabilities Debt Equity Kris currently has 50 million shares outstanding. The book value per share is $50, while the current market price is $80 per share. Kris pays a dividend of $4 per share and has a price/earnings ratio of 10. The stock currently has a beta of 1.2. The debt of Kris Corporation is in the form of long-term bonds with a coupon rate of 10%. The bonds are currently rated AA and are selling at a yield of 12%. The market value of the bonds is 80% of the face value. 2500 2500 Kris is considering a major change in its capital structure. It has two options: Option 1: Issue $1 billion in new stock and repurchase half of its outstanding debt. This will make it an AAA rated firm (AAA rated debt is yielding 11% in the marketplace). Option 2: Issue $3 billion in new debt to buy back stock. This will drop its rating to CCC (CCC rated debt is yielding 18% in the market place). The risk-free rate is 8% and the market risk premium is 5.5%. The corporate marginal tax rate is 40%. The company has no preferred stock. a. Estimate the current cost of capital for Kris. b. Estimate the current cost of capital for Kris under each option. (5 marks) (9 marks) c. From a cost of capital standpoint, which of the two options would you pick? Or would you stay with the current capital structure? (3 marks) d. Based on the business that Kris operates in, evaluate the indirect bankruptcy costs that may accrue to Kris's business. What role (if any) would the indirect bankruptcy costs play in Kris's capital structure decision? Kris Corporation is a leading automobile manufacturer. The balance sheet of the company is as follows (in millions): Assets Fixed Assets Current Assets 4000 1000 . Liabilities Debt Equity Kris currently has 50 million shares outstanding. The book value per share is $50, while the current market price is $80 per share. Kris pays a dividend of $4 per share and has a price/earnings ratio of 10. The stock currently has a beta of 1.2. The debt of Kris Corporation is in the form of long-term bonds with a coupon rate of 10%. The bonds are currently rated AA and are selling at a yield of 12%. The market value of the bonds is 80% of the face value. 2500 2500 Kris is considering a major change in its capital structure. It has two options: Option 1: Issue $1 billion in new stock and repurchase half of its outstanding debt. This will make it an AAA rated firm (AAA rated debt is yielding 11% in the marketplace). Option 2: Issue $3 billion in new debt to buy back stock. This will drop its rating to CCC (CCC rated debt is yielding 18% in the market place). The risk-free rate is 8% and the market risk premium is 5.5%. The corporate marginal tax rate is 40%. The company has no preferred stock. a. Estimate the current cost of capital for Kris. b. Estimate the current cost of capital for Kris under each option. (5 marks) (9 marks) c. From a cost of capital standpoint, which of the two options would you pick? Or would you stay with the current capital structure? (3 marks) d. Based on the business that Kris operates in, evaluate the indirect bankruptcy costs that may accrue to Kris's business. What role (if any) would the indirect bankruptcy costs play in Kris's capital structure decision?
Expert Answer:
Answer rating: 100% (QA)
a To estimate the current cost of capital for Kris we need to calculate the weighted average cost of capital WACC The WACC is the average rate of return required by the companys investors taking into ... View the full answer
Related Book For
Intermediate Accounting
ISBN: 978-1118147290
15th edition
Authors: Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
Posted Date:
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