Question 3

i) The balance sheet for Trip Advisor. is shown here in market value terms. There are 3,000 shares of stock outstanding.

Market Value Balance Sheet

Cash $20,000 Equity $200,000

Fixed assets $180,000 Total $200,000

Total $200,000

The company has announced that it is going to repurchase $5000 worth of stock. What will the price of the stock be after this repurchase?

ii) Alpha Co. expects an EBIT of $8,000 every year forever. The firm currently has no debt, and its cost of equity is 15 %. The firm can borrow at 7 % and the corporate tax rate is 30 %. What will the value of the firm be if it converts to 50 % debt?

iii) Peter Manufacturing expects its EBIT to be $200,000 every year forever. The firm can borrow at 10 %. Peters currently has no debt, and its cost of equity is 15 %. The tax rate is 35 %. Peters will borrow $80,000 and use the proceeds to repurchase shares. What will the WACC be after recapitalization?

iv) How can a CFO convince the senior management to utilize excess cash reserves for the company and not for paying them out as dividends?

v) What is the significance of capital structure under M&M proposition one with and without taxes? And what is the significance is based on the trade-off theory?