ans-odd-problems-ch15

# ans-odd-problems-ch15 - CHAPTER 15 CAPITAL STRUCTURE BASIC...

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CHAPTER 15 CAPITAL STRUCTURE: BASIC CONCEPTS Answers to odd-numbered questions Basic 1. a. A table outlining the income statement for the three possible states of the economy is shown below. The EPS is the net income divided by the 2,500 shares outstanding. The last row shows the percentage change in EPS the company will experience in a recession or an expansion economy. Recession Normal Expansion EBIT \$5,600 \$14,000 \$18,200 Interest 0 0 0 NI \$5,600 \$14,000 \$18,200 EPS \$ 2.24 \$ 5.60 \$ 7.28 % EPS –60 ––– +30 b. If the company undergoes the proposed recapitalization, it will repurchase: Share price = Equity / Shares outstanding Share price = \$150,000/2,500 Share price = \$60 Shares repurchased = Debt issued / Share price Shares repurchased =\$60,000/\$60 Shares repurchased = 1,000 The interest payment each year under all three scenarios will be: Interest payment = \$60,000(.05) = \$3,000 The last row shows the percentage change in EPS the company will experience in a recession or an expansion economy under the proposed recapitalization. Recession Normal Expansion EBIT \$5,600 \$14,000 \$18,200 Interest 3,000 3,000 3,000 NI \$2,600 \$11,000 \$15,200 EPS \$1.73 \$ 7.33 \$10.13 % EPS –76.36 ––– +38.18 3. a. Since the company has a market-to-book ratio of 1.0, the total equity of the firm is equal to the market value of equity. Using the equation for ROE:

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ROE = NI/\$150,000 The ROE for each state of the economy under the current capital structure and no taxes is: Recession Normal Expansion ROE .0373 .0933 .1213 % ROE –60 ––– +30 The second row shows the percentage change in ROE from the normal economy. b. If the company undertakes the proposed recapitalization, the new equity value will be: Equity = \$150,000 – 60,000 Equity = \$90,000 So, the ROE for each state of the economy is: ROE = NI/\$90,000 Recession Normal Expansion ROE .0222 .1156 .1622 % ROE –76.36 ––– +38.18 c. If there are corporate taxes and the company maintains its current capital structure, the ROE is: ROE .0243 .0607 .0789 % ROE –60 ––– +30 If the company undertakes the proposed recapitalization, and there are corporate taxes, the ROE for each state of the economy is: ROE .0144 .0751 .1054 % ROE –76.36 ––– +38.18 Notice that the percentage change in ROE is the same as the percentage change in EPS. The percentage change in ROE is also the same with or without taxes. 5. We can find the price per share by dividing the amount of debt used to repurchase shares by the number of shares repurchased. Doing so, we find the share price is: Share price = \$1,500,000/(150,000 – 60,000) Share price = \$16.67 per share The value of the company under the all-equity plan is: V = \$16.67(150,000 shares) = \$2,500,000 And the value of the company under the levered plan is:
V = \$16.67(60,000 shares) + \$1,500,000 debt = \$2,500,000 7. To find the value per share of the stock under each capitalization plan, we can calculate the price as the value of shares repurchased divided by the number of shares repurchased. So,

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## This note was uploaded on 02/14/2011 for the course FINANCE 620 taught by Professor Halstead during the Fall '09 term at UMBC.

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ans-odd-problems-ch15 - CHAPTER 15 CAPITAL STRUCTURE BASIC...

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