Problem 1
Premium for Financial Risk
Ethier Enterprise has an unlevered beta of 1. Ethier is financed with 60% debt and has a levered beta of 1.2. If the risk free rate is 4% and the market risk premium is 6%, how much is the additional premium that Ethier's shareholders require to be compensated for financial risk? Round your answer to two decimal places.
Problem 2
External Equity Financing
Gardial GreenLights, a manufacturer of energy efficient lighting solutions, has had such success with its new products that it is planning to substantially expand its manufacturing capacity with a $20 million investment in new machinery. Gardial plans to maintain its current 30% debt-to-total-assets ratio for its capital structure and to maintain its dividend policy in which at the end of each year it distributes 30% of the year's net income. This year's net income was $8 million. How much external equity must Gardial seek now to expand as planned? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
Problem 3
Dividend Payout
The Wei Corporation expects next year's net income to be $15 million. The firm's debt ratio is currently 50%. Wei has $10 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the form of dividends), how large should Wei's dividend payout ratio be next year? Round your answer to two decimal places.
Problem 4
Stock Repurchase
Bayani Bakery's most recent FCF was $50 million; the FCF is expected to grow at a constant rate of 6%. The firm's WACC is 12% and it has 15 million shares of common stock outstanding. The firm has $30 million in short-term investments, which it plans to liquidate and distribute to common shareholders via a stock repurchase; the firm has no other nonoperating assets. It has $363 million in debt and $65 million in preferred stock.
a. What is the value of operations? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
b. Immediately prior to the repurchase, what is the intrinsic value of equity? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
c. Immediately prior to the repurchase, what is the intrinsic stock price? Round your answer to the nearest cent.
d. How many shares will be repurchased? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
How many shares will remain after the repurchase? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
e. Immediately after the repurchase, what is the intrinsic value of equity? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
The intrinsic stock price? Round your answer to two decimal places.
Problem 5
Residual Distribution Model
Puckett Products is planning for $2.2 million in capital expenditures next year. Puckett's target capital structure consists of 35% debt and 65% equity. If net income next year is $2.1 million and Puckett follows a residual distribution policy with all distributions as dividends, what will be its dividend payout ratio? Round your answer to two decimal places.
Problem 6
WACC and Optimal Capital Structure
F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows:
|
Market Debt-
to-Value
Ratio (wd)
|
Market Equity-to-Value
Ratio (ws)
|
Market Debt-
to-Equity
Ratio (D/S)
|
Before-Tax Cost of Debt (rd)
|
|
0.0
|
1.0
|
0.00
|
7.0%
|
|
0.2
|
0.8
|
0.25
|
8.0
|
|
0.4
|
0.6
|
0.67
|
10.0
|
|
0.6
|
0.4
|
1.50
|
12.0
|
|
0.8
|
0.2
|
4.00
|
15.0
|
F. Pierce uses the CAPM to estimate its cost of common equity, rs. The company estimates that the risk-free rate is 6%, the market risk premium is 6%, and the company's tax rate is 30%. F. Pierce estimates that its beta now (which is "unlevered" since it currently has no debt) is 1.15. Based on this information, what is the firm's optimal capital structure, and what would the weighted average cost of capital be at the optimal capital structure? Do not round intermediate calculations. Round your answers to two decimal places.
DEBT %
EQUITY %
WACC %
Problem 7
Capital Structure Analysis
Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $12.92 million, and its tax rate is 15%. Pettit can change its capital structure either by increasing its debt to 65% (based on market values) or decreasing it to 35%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 7% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change.
The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%.
Present situation (50% debt):
What is the firm's WACC? Round your answer to three decimal places.
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
65% debt:
What is the firm's WACC? Round your answer to two decimal places.
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
35% debt:
What is the firm's WACC? Round your answer to two decimal places.
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
Problem 8
Stock Split
JPix management is considering a stock split. JPix currently sells for $125 per share, and a 3-for-1 stock split is contemplated. What will be the company's stock price following the stock split assuming that the split has no effect on the total market value of JPix's equity? Round your answer to the nearest cent.