# Sheehan Corp. is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding shares

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## Question:

Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?Net Income Payout?

Pavlin Corp.'s projected capital budget is $2,000,000, its target capital structure is 40% debt and 60% equity, and its forecasted net income is $1,000,000. If the company follows a residual dividend policy, how much dividends will it pay or, alternatively, how much new stock must it issue?

Dividends Stock Issued?

The following data apply to Grullon-Ikenberry Inc. (GII):

Value of operations $1,000, Short-term investments $100, Debt $300, Number of shares 100; The company plans on distributing $50 million as dividend payments. What will the intrinsic per share stock price be immediately after the distribution?

Keys Financial has done extremely well in recent years, and its stock now sells for $175 per share. Management wants to get the price down to a more typical level, which it thinks is $25 per share. What stock split would be required to get to this price, assuming the transaction has no effect on the total market value? Put another way, how many new shares should be given per one old share?

Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be?

EBIT $2,000,000 Capital budget $850,000

Interest rate 10% % Debt 40%

Debt outstanding $5,000,000 % Equity 60%

Shares outstanding $5,000,000 Tax rate 40%

Lauterbach Corporation uses no debt, its beta is 1.10, and its tax rate is 40%. However, the CFO is considering moving to a capital structure with 30% debt and 70% equity. If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?

9. Ang Enterprises has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Ang's beta be if it used no debt, i.e., what is its unlevered beta?

10. Simon Software Co. is trying to estimate its optimal capital structure. Right now, Simon has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6% and the market risk premium, rM - rRF, is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Simon's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?

11. Michaely Inc. is an all-equity firm with 200,000 shares outstanding. It has $2,000,000 of EBIT, which is expected to remain constant in the future. The company pays out all of its earnings, so earnings per share (EPS) equal dividends per shares (DPS). Its tax rate is 40%. The company is considering issuing $5,000,000 of 10.0% bonds and using the proceeds to repurchase stock. The risk-free rate is 6.5%, the market risk premium is 5.0%, and the beta is currently 0.90, but the CFO believes beta would rise to 1.10 if the recapitalization occurs. Assuming that the shares can be repurchased at the price that existed prior to the recapitalization, what would the price be following the recapitalization?

12. BB has an EBIT of $100,000, a tax rate of 40%. BB is considering moving to a capital structure that is comprised of 20% debt and 80% equity, based on market values. The debt would have an interest rate of 7%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise to 14%. If this plan were carried out, what would BB's new value of operations be?

13. Whited Products recently completed a 4-for-1 stock split. Prior to the split, its stock sold for $120 per share. If the firm's total market value increased by 5% as a result of increased liquidity caused by the split, what was the stock price following the split?

14. Brooks Corp.'s projected capital budget is $2,000,000, its target capital structure is 60% debt and 40% equity, and its forecasted net income is $600,000. If the company follows a residual dividend policy, what total dividends, if any, will it pay out?

15. Ross Financial has suffered losses in recent years, and its stock currently sells for only $0.50 per share. Management wants to use a reverse split to get the price up to a more "reasonable" level, which it thinks is $25 per share. How many of the old shares must be given up for one new share to achieve the $25 price, assuming this transaction has no effect on total market value?

16: Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be if EBIT is $2,000,000, Capital budget $850,000, Interest rate 10%, Debt 40%, Debt outstanding $5,000,00, Equity 60%, Shares outstanding $5,000,000, and the Tax rate is 40%?

17: Mortal Inc. expects to have a capital budget of $500,000 next year. The company wants to maintain a target capital structure with 30% debt and 70% equity, and its forecasted net income is $400,000. If the company follows the residual dividend policy, how much in dividends, if any, will it pay?

18. Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the market value capital structure indicated below. The money raised would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.

EBIT = $80,000 New Debt/Value = 20%

Growth = 0% New Equity/Value = 80%

Orig cost of equity, rs = 10.0% No. of shares = 10,000

New cost of equity = rs =11.0% Price per share = $48.00

Tax rate = 40% Interest rate = rd = 7.0%

Based on the data in the previous two problems, what would the stock price be if VF issued the new debt and immediately used the proceeds to repurchase stock?

19. Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the market value capital structure indicated below. The money raised would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.

EBIT = $80,000 New Debt/Value = 20%

Growth = 0% New Equity/Value = 80%

Orig cost of equity, rs = 10.0% No. of shares = 10,000

New cost of equity = rs =11.0% Price per share = $48.00

Tax rate = 40% Interest rate = rd = 7.0%

Now assume that VF is considering changing from its original zero debt capital structure to a new capital structure with even more debt. This results in changes in the cost of debt and equity, and thus to a new WACC and a new value of operations. Assume VF raises the amount of new debt indicated below and uses the funds to purchase and hold T-bills until it makes the stock repurchase. What is the stock price per share immediately after issuing the debt but prior to the repurchase?

Debt/Value = 40% Value of new debt = $213,333

Equity/Value= 60% New WACC = 9.0%

20. Dabney Electronics currently has no debt. Its operating income is $20 million and its tax rate is 40%. It pays out all of its net income as dividends and has a zero growth rate. The current stock price is $40 per share, and it has 2.5 million shares of stock outstanding. If it moves to a capital structure that has 40% debt and 60% equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10%. What would its stock price be if it changes to the new capital structure?

**Related Book For**

## Marketing Research

ISBN: 978-1118156636

11th edition

Authors: David A. Aaker, V. Kumar, Robert Leone, George S. Day