CAPITAL STRUCTURE AND DIVIDENDS
Analyzing a Firm's Capital Structure
Assume that a company has $10 million in assets (where the market value of the assets is equal to the book value of the assets) and no debt. The company's marginal tax rate is 35% and has 500,000 shares outstanding. The company's earnings before interest and taxes (EBIT) is $3.88 million. The firm's stock price is $27 per share and the cost of equity is 11%.
The company is thinking of issuing bonds and simultaneously repurchasing a portion of its stock. If the company changes its capital structure from no debt to 25% debt based on market values, the firm's cost of equity will increase to 13% because of the increased risk. The bonds can be sold at a cost of 9%. The firm's earnings are not expected to grow over time. All of its earnings will be paid out as dividends.
Answer the following questions:
What impact will this utilization of this debt have on the value of the company?
What's going to be the company's EPS after the recapitalization?
What's going to be the company's new stock price?
The $3.88 million EBIT discussed above is determined from this probability distribution:
Probability
EBIT ($)
0.05
- 1 million
0.25
2.3 million
0.4
4 million
0.25
5.8 million
0.05
6.1 million
What's the times interest earned ratio at each probability level?
Assignment Expectations
You are expected to:
Describe the purpose of the report and provide a conclusion. An introduction and a conclusion are important because many busy individuals in the business environment may only read the first and the last paragraph. If those paragraphs are not interesting, they never read the body of the paper.
Answer the Case Assignment question(s) clearly and provide necessary details.
Write clearly and correctly-that is, no poor sentence structure, no spelling and grammar mistakes, and no run-on sentences.
Provide citations to support your argument and references on a separate page. (All the sources that you listed in the references section must be cited in the paper.) Use APA format to provide citations and references.
Type and double-space the paper.
Whenever appropriate, please use Excel to show supporting computations in an appendix, present financial information in tables, and use the data computed to answer follow-up questions. In finance, in addition to being able to write well, it's important to present information in a professional manner and to analyze financial information. This is part of the assignment expectations and will be considered for grading purposes.