Please do 2 & 3. I have the answer correct listed for 1 for reference, if needed.
Capital Structure Theory Problem 15-8 Capital Structure Analysis
The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
Assets (Market value = book value) $3,000,000
EBIT $500,000
Cost of equity, rs 10%
Stock price, Po $15
Shares outstanding, no 200,000
Tax rate, T (federal-plus-state) 40%
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 13% to reflect the increased risk. Bonds can be sold at a cost, rd, of 8%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.
What effect would this use of leverage have on the value of the firm?
1) What would be the price of Rivoli's stock? Round your answer to the nearest cent. CORRECT ANSWER= $14.11 PER SHARE
2) What happens to the firm's earnings per share after the recapitalization? Round your answer to the nearest cent. The firm INCREASED its EPS by $ ______. (?)
3) The $500,000 EBIT given previously is actually the expected value from the following probability distribution:
Probability EBIT .10 $115,000 .20 $200,000 .40 $400,000 .20 $850,000 .10 $1,415,000
Determine the times-interest-earned ratio for each probability. Round your answers to two decimal places.
Probability TIE .10 ? .20 ? .40 ? .20 ? .10 ?
What is the probability of not covering the interest payment at the 30 percent debt level? Round your answer to two decimal places. %.
Please do 2 & 3. I have the answer correct listed for 1 for reference, if needed.
Capital Structure Theory Problem 15-8 Capital Structure Analysis
The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
Assets (Market value = book value) $3,000,000
EBIT $500,000
Cost of equity, rs 10%
Stock price, Po $15
Shares outstanding, no 200,000
Tax rate, T (federal-plus-state) 40%
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 13% to reflect the increased risk. Bonds can be sold at a cost, rd, of 8%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.
What effect would this use of leverage have on the value of the firm?
1) What would be the price of Rivoli's stock? Round your answer to the nearest cent. CORRECT ANSWER= $14.11 PER SHARE
2) What happens to the firm's earnings per share after the recapitalization? Round your answer to the nearest cent. The firm INCREASED its EPS by $ ______. (?)
3) The $500,000 EBIT given previously is actually the expected value from the following probability distribution:
| Probability | EBIT |
| .10 | $115,000 |
| .20 | $200,000 |
| .40 | $400,000 |
| .20 | $850,000 |
| .10 | $1,415,000 |
Determine the times-interest-earned ratio for each probability. Round your answers to two decimal places.
| Probability | TIE |
| .10 | ? |
| .20 | ? |
| .40 | ? |
| .20 | ? |
| .10 | ? |
What is the probability of not covering the interest payment at the 30 percent debt level? Round your answer to two decimal places. %.
