Assignment

Using the mini case information, write a 250-500 word recommendation of the financial decisions you propose for this company based on an analysis of its capital structure and capital budgeting techniques.

Assume you have been hired as a business manager for PizzaPalace, a regional pizza restaurant chain. The company's EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity and it has 10 million shares outstanding. When you took your corporate finance course your instructor stated that most firms owners would be financially better off if the firms used some debt. When you suggested this to your new boss he encouraged you to pursue the idea. As a first step assume that you obtained from the firms investment banker the following estimated costs of debt for the firm at different aital structures:

Percent financed with debt      rd
0%                                        -
20                                       8%
30                                       8.5
40                                      10.0
50                                      12.0

If the company were to recapitalize, then debt would beissued and the funds received would be used to repurchase stock. PizzaPalace is in the 40% state -plus-federal corporate tax bracket, its beta is 1.0, the risk free rate is 6% and the market risk premium is 6%.

A.) Using the free cash flow valuation model, show only the avenues by which capital structure can affect value.

B.) 1.) What is the business risk? What factors influence a firms business risk?

2.) what is operating leverage and how does it affect a firms business risk? Show the operating breakeven point if a company has fixed costs of $200, a sales price of $15 and variable costsof $10.