BFN 110 Lecture Notes - Lecture 18: Tunxis Community College, Issued Shares, Interest Rate

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coralimpala133

6 Jan 2021

School

Tunxis Community College

Department

Business – Finance

Course

BFN 110

Professor

garside

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Document Summary

Use eps analysis to select a financing option. Results from the presence of fixed financial costs. This magnifies the effects of changes in ebit on eps. Changes in the use of debt is related to firm"s financing decision. A firm is considering a capital structure change. The firm is currently financed by equity only has 100k shares outstanding at a price of each. It"s investigating a 80k debt issue at a 10% interest rate to repurchase 40k shares. The eps for various levels of ebit for each financing choice are as follows. Assume the following current info for a firm. The firm plans to issue m debt to repurchase equity 4m/ = Eps can be increased by increasing debt. The mixture of debt and equity used to finance the assets. Changing the debt-equity ratio will change the capital structure. If firm uses debt to replace equity. Financial risk, impact is measured in changes to eps.

Related Questions

Reliable Gearing currently is all-equity-financed. It has 18,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $340,000 with the proceeds used to buy back stock. The high-debt plan would exchange $500,000 of debt for equity. The debt will pay an interest rate of 10.8%. The firm pays no taxes.

a.	What will be the debt-to-equity ratio after each contemplated restructuring? (Round your answers to 2 decimal places.)

	Debt-to-Equity Ratio
Low-debt plan
High-debt plan

b-1.

If earnings before interest and tax (EBIT) will be either $130,000 or $190,000, what will be earnings per share for each financing mix for both possible values of EBIT? (Round your answers to 2 decimal places.)

	Earnings Per Share
EBIT	Low-Debt Plan	High-Debt Plan
$130,000	$	$
$190,000

b-2.

If both scenarios are equally likely, what is expected (i.e., average) EPS under each financing mix? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Earnings Per Share
Low-debt plan	$
High-debt plan

b-3.

Is the high-debt mix preferable?

	No
	Yes

c.	Suppose that EBIT is $194,400. What is EPS under each financing mix? (Round your answers to 2 decimal places.)

	Earnings Per Share
Low-debt plan	$
High-debt plan

beigekoala601

As CFO of Duke Corp., you are considering a recapitalization plan that would convert Duke Corp. from its current all-equity capital structure to one that includes substantial financial leverage. Duke now has 600,000 shares of common stock outstanding, which are selling for $55 each. You expect the firmâs EBIT to be $3,000,000 for the near future. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then the EBIT will be 40 percent lower.

The recapitalization proposal is to issue $8,250,000 worth of long-term debt, at an interest rate of 6.0 %, and then to use the proceeds to repurchase 150,000 shares of common stock worth $8,250,000. Assuming there are no market frictions such as corporate or personal income taxes,

(a) Calculate the expected ROE and EPS for Duke Corp under each of the three economic scenarios before any debt issue using the table below

Cash Flows to Stockholders and Bondholders Under Current Capital Structure
	Recession	Normal	Expansion
EBIT
Interest (6.0%)
Net income
Shares outstanding
Earnings per share
Return on equity (P0 = $55.00/sh)

(b) Repeat part (a) assuming that the company goes through with recapitalization using the table

Cash Flows to Stockholders and Bondholders Under Proposed Recapitalization
	Recession	Normal	Expansion
EBIT
Interest (6.0%)
Net income
Shares outstanding
Earnings per share
Return on equity (P0 = $55.00/sh)

oliveelephant279

QUESTION 1

BMC Inc. currently has $1,000,000 of 8% coupon bonds and 40,000 common shares outstanding. The tax rate is 40%. The firm is considering a large investment of $1,500,000 in a new project. The following options are feasible for raising this capital: ï· Option 1: Sell $1,500,000 worth of common stock at $50 per share. ï· Option 2: Issue $1,000,000 worth of 6% coupon bonds with a 20-year maturity, in addition to $500,000 worth of common stock at $50 per share.

a) Calculate the EBIT indifference point for the 2 options.

b) What is the EPS at the EBIT indifference point? At EBIT levels above the EBIT indifference point, which plan is better?

QUESTION 2

B&B Inc. has a book value of debt of $500,000. The market value of debt is $550,000. Its pre-tax cost of debt is 10%, and its beta is equal to 2. The tax rate is 40%. The firm has an annual EBIT of $200,000. In the market, you observe that T-bills are being sold to yield 1%, and the S&P/TSX Composite Index is expected to yield 6%.

What is B&Bâs weighted average cost of capital? Assume there is no cost of financial distress.

QUESTION 3

An unlevered firm, CEA Inc., has 160,000 common shares issued and outstanding. It has a perpetual constant EBIT of $800,000 and an unlevered beta of 1.5. The firm has corporate tax rate of 40%. The market risk premium is 8% and the risk- free rate is 3%. Assume a world of taxes and costs of financial distress.

a) Calculate the value of the firm.

b) Calculate the WACC for the firm.

c) What is the value of a share in the company and what is the EPS?

d) If the firm issues $1,000,000 of bonds with a coupon rate of 10%, and now the beta of the levered firm is 1.85, what is the value of the firm?

e) What is the WACC for the firm with its new capital structure?

BFN 110 Lecture Notes - Lecture 18: Tunxis Community College, Issued Shares, Interest Rate

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