Scott Motor Cars is currently all equity financed. It has 200,000 shares of equity outstanding, selling at
Question:
Scott Motor Cars is currently all equity financed. It has 200,000 shares of equity outstanding, selling
at $53 per share. The firm is expected to produce a perpetual EBIT of $950,000, and its expected
dividend payout is 100%. The firm is considering a capital structure change. The new capital
structure would have $3,000,000 debt, with a 6% interest rate. The company would use the debt
proceeds to repurchase stock. Assume that the restructuring plan will not change the value of the
firm. The firm's tax rate is 0%.
A. How many shares of stock will the company repurchase?
B. What are the firm's debt and equity percentages after the restructuring?
C. What will the required return on equity be after the firm issues the debt? (Assume that the
firm will continue to pay 100% of its EPS as a dividend each year, forever).
D. At what level of EBIT will the two plans produce the same EPS?
E. Which plan will the shareholders prefer if the perpetual EBIT turns out to be (in each case,
you must briefly explainand support numericallyyour answer):
Perpetual EBIT = $800,000
Perpetual EBIT = $950,000
Perpetual EBIT = $1,100,000