Capital Structure and Leverage 8

Capital Structure and Leverage 8 - 6. Your company is an...

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Old Exam Questions - Capital Structure and Leverage Page 8 of 31 Pages 6. Your company is an all-equity firm with 300,000 shares outstanding. The company’s EBIT is $2,500,000, and EBIT is expected to remain constant over time. The company pays out all of its earnings each year, so its earnings per share equals its dividends per share. The company’s tax rate is 40 percent. The company is considering issuing $5 million worth of bonds (at par) and using the proceeds for a stock repurchase. If issued, the bonds would have an estimated yield to maturity of 8 percent. The risk-free rate in the economy is 5 percent, and the market risk premium is 5 percent. The company’s beta is currently 1.0, but its investment bankers estimate that the company’s beta would rise to 1.4 if it proceeds with the recapitalization. Assume that as soon as the announcement is made that the firm will recapitalize, the market price of the stock increases in anticipation of the recapitalization and that the
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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