Section__8__Bullseye

# Section__8__Bullseye - Section#8"Capital Structure Case...

This preview shows pages 1–11. Sign up to view the full content.

Section #8 “Capital Structure Case Analysis: The Bullseye Corporation” March 25th, 2009 Copyright 2009 by Rich Curtis

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
A. Valuing The Common Stock Of The Unlevered Firm (See “Bullseye” Case, pp. 1-2) 1. Assume that the Bullseye Corporation currently has no debt but has 1,000,000 shares of common stock outstanding. The corporate tax rate is 35%. Each year, all the corporation’s after-tax earnings are paid to the common stockholders as a cash dividend. The cash dividends are paid annually with the next cash dividend being paid one year from today. Also assume that EBIT = \$15,384,615.38 each year, Net Income = (1-t c )(\$15,384,615.38) = (1-.35)(\$15,384,615.38) = \$10,000,000 each year, and k e (0) = the after-tax cost of equity of the unlevered firm = .20
2. Then the total market value of the unlevered firm equals the market value of the common stock since there is no debt outstanding. 3. Questions : What is the total market value of the common stock of the the Bullseye Corporation and what is the price per share?

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Answers : Total Equity Value = Dividend k e (0) = \$10,000,000 .20 = \$50,000,000 Net Income P S = \$50,000,000 1,000,000 shares = \$50/share
B. Substitute \$40,000,000 Of Debt For The Common Stock Equity (See “Bullseye” Case, pp. 3-6) 4. Now assume that the Bullseye Corporation issues \$40,000,000 of perpetual debt and pays the proceeds to the common stockholders as a common stock cash dividend. The cash dividend will therefore be \$40 per share. The assets of the firm will be unchanged since the cash raised is immediately paid out.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
5. The market value of the levered firm, V L , is given by the following expression: V L = V U + t c B = \$50,000,000 + (.35)(\$40,000,000) = \$64,000,000. The overall value of the firm has increased because the debt shields some EBIT from taxes. More of EBIT goes to investors in the firm’s securities--less goes to the Internal Revenue Service.
6. Since the market value of the levered firm, V L , equals the market value of the bonds outstanding plus the market value of the common stock outstanding, one can solve for the market value of the outstanding common stock. Questions : What is the total market value of the outstanding common stock of “The Bullseye Corporation” after the \$40 million bond issuance and the payment of the \$40 million cash dividend? What is the new common stock price per share?

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Answers : S L = V L B L = \$64,000,000 \$40,000,000 = \$24,000,000 P S = \$24,000,000 1,000,000 shares = \$24/share
Let’s look at the annual tax savings and also the dividends received by the stockholders to see if our results are consistent with a cash flow analysis. (I hope they are or my intuition is messed up!!)

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
EBIT = \$15,384,615.38 Interest @ 8% = \$3,200,000.00 (8% is Assumed) Taxable Income = \$12,184,615.38 Tax @ 35% = \$4,264,615.38 Net Income = \$7,920,000.00 = Annual Dividend Note : The annual tax saving is: \$5,384,615.38 - \$4,264,615.38 = \$1,120,000 Discounting the annual tax savings “perpetuity”
This is the end of the preview. Sign up to access the rest of the document.

## This note was uploaded on 09/03/2009 for the course AEM 3240 taught by Professor Curtis,r. during the Spring '07 term at Cornell.

### Page1 / 43

Section__8__Bullseye - Section#8"Capital Structure Case...

This preview shows document pages 1 - 11. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online