Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value. Right now, Cartwright has no debt in its but plans to borrow $6 million with interest rate of 8%. The risk-free rate is 6% and the market risk premium, (RM - RF), is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%.
Use the following information to answer questions a through d.
Market Values Current cap. Structure Proposed cap. Structure
Assets $15 million $15 million
Debt $0 $6 million
Equity $15 million $9 million
Share price $25.00
Shares outstanding 600,000 ???
Bond Interest rate N/A 8%
The company is expected to generate $3.5 million in revenue.
A) What is EPS under the current capital structure?
B) What is EPS for the proposed capital structure?
C) What is ROE for the proposed capital structure?
D) What would be Cartwright's estimated cost of equity if it were to change its capital structure?
E) How many shares are outstanding under the proposed capital structure?
F) What would its stock price be if it changes to the new capital structure?