Practice_problems_capital_structure3-KEY.pdf - Finance 550...

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1 Finance 550 Practice Problems Capital Structure 3 - KEY M&M CERTAINLY DESERVE THEIR PROPS Questions 1-6 Hold’em Enterprises is a manufacturer of playing cards and poker chips. The company is publicly traded on the NYSE with the ticker symbol BET and currently sells for $22 per share. Last year, the firm had an EBIT of $4,400 and it is expected that EBIT will remain constant forever. All of the firm’s earnings are paid out as dividends and in the prior year the firm paid dividends of $4.40 per share. The firm pays 30% in taxes (which accounts for both federal and state). The firm currently has no debt. Currently, the risk-free rate is 8%. The return on the market portfolio is unknown, but it is expected that in each and every year, there is an even chance that the market will either decrease by 2% or increase by 22%. The firm is deciding whether to issue some debt and use the proceeds to repurchase equity. The firm has determined that the cost of their debt will be 8% and they plan to issue perpetual debt at par value. No one but management knows of the decision to do the restructuring. They plan on announcing they are going to change their capital structure on January 3 rd , but they won’t actually undertake the capitalization until January 5 th . The market is semi-strong form efficient (in other words, prices will fully react as soon as the news is released). Despite the fact that they don’t issue the debt until Jan 5 th , for simplicity, assume that they will pay interest on the debt as if it had been outstanding for the full year. Assume that no other events/information which affect the valuation of the firm occur between Jan 1 st and Jan 6 th . You should also assume that investors are aware of the firm’s earnings prospects and thus the restructuring will not signal anything about future earnings to the market. Additionally there are no costs associated with financial distress.
1. What is the WACC of Hold’em?
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