Capital Structure and Leverage 23

Capital Structure and Leverage 23 - E 39 $1.99 Assume that...

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Old Exam Questions - Capital Structure and Leverage Page 23 of 31 Pages E. $1.99 39. Assume that your company is an all-equity firm with 250,000 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 are equal to its dividends per share and this is currently $6.00 per share. The company’s tax rate is 40 percent, its current cost of stock, K S , is 8 percent, and its current stock price is $75 per share. Now assume that the company is considering issuing $3.75 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 5 percent or interest of $187,500. The risk-free rate in the economy is 4 percent, and the market risk premium is 5 percent. The company’s beta is currently 0.8, but its investment bankers estimate that the company’s beta would rise to 0.9 if it proceeds with the recapitalization.
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