# capstap1 - Capital Structure Changes Problem 1 a There are...

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Capital Structure Changes Problem 1 a. There are a number of ways in which BMD can increase its debt ratio _ 1. It can borrow \$ 1.15 billion and buy back stock. 2. It can borrow \$ 1.15 billion and pay special dividends. 3. It can borrow more than \$ 1.15 billion and take projects over time, in which case its optimal dollar debt will be higher. For instance, if the money is borrowed now to take projects, the debt needed can be estimated approximately: X/(2300+X) = 0.5 Solving for X, X = 2300 b. From the viewpoint of the effect on equity, there is no difference between repurchasing stock and paying a special dividend. There may be a tax difference to the recipient, since dividends and capital gains are taxed differently. c. If BMD has a cash balance of \$ 250 million, it can use this cash to buy back stock. BMD, therefore, needs to borrow only \$ 1.025 billion to get to 50%. Problem 2 a.) Current 1 2 3 4 5 Debt 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ Equity 900.00 \$ 1,003.95 \$ 1,119.72 \$ 1,248.68 \$ 1,392.35 \$ 1,552.42 \$ D/(D+E) 10.00% 9.06% 8.20% 7.41% 6.70% 6.05% D/E 11.11% 9.96% 8.93% 8.01% 7.18% 6.44% Net Income 67.50 \$ 74.25 \$ 81.68 \$ 89.84 \$ 98.83 \$ 108.71 \$ Dividends 13.50 \$ 14.85 \$ 16.34 \$ 17.97 \$ 19.77 \$ 21.74 \$ Beta 1.10 1.09 1.09 1.08 1.08 1.07 Expected Retur 13.05% 13.01% 12.98% 12.94% 12.92% 12.89% Dividend Yield 1.50% 1.48% 1.46% 1.44% 1.42% 1.40% Exp. Price App 11.55% 11.53% 11.52% 11.51% 11.50% 11.49% b.) Current 1 2 3 4 5 Debt 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ Equity 900.00 \$ 945.45 \$ 988.76 \$ 1,028.80 \$ 1,064.20 \$ 1,093.31 \$ D/(D+E) 10.00% 9.57% 9.18% 8.86% 8.59% 8.38% D/E 11.11% 10.58% 10.11% 9.72% 9.40% 9.15% Net Income 67.50 \$ 74.25 \$ 81.68 \$ 89.84 \$ 98.83 \$ 108.71 \$ Dividends 27.00 \$ 29.70 \$ 32.67 \$ 35.94 \$ 39.53 \$ 43.48 \$ Stock Buybacks 45.00 \$ 50.20 \$ 55.99 \$ 62.43 \$ 69.62 \$ Beta 1.10 1.10 1.09 1.09 1.09 1.09 Expected Retur 13.05% 13.03% 13.02% 13.00% 12.99% 12.98% Dividend Yield 3.00% 3.14% 3.30% 3.49% 3.71% 3.98% Exp. Price App 10.05% 9.89% 9.71% 9.51% 9.28% 9.01% Page 1

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Capital Structure Changes Problem 3 a) If the existing policy of paying \$ 50 million in dividends is continued. Current 1 2 3 4 5 Debt 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ Equity 5,000.00 \$ 5,630.00 \$ 6,330.09 \$ 7,108.06 \$ 7,972.58 \$ 8,933.28 \$ D/(D+E) 50.00% 47.04% 44.13% 41.29% 38.54% 35.89% D/E 100.00% 88.81% 78.99% 70.34% 62.71% 55.97% Dividends 50.00 \$ 50.00 \$ 50.00 \$ 50.00 \$ 50.00 \$ 50.00 \$ Beta 1.20 1.15 1.11 1.07 1.03 1.00 Expected Retur 13.60% 13.32% 13.08% 12.87% 12.68% 12.51% Dividend Yield 1.00% 0.89% 0.79% 0.70% 0.63% 0.56% Exp. Price App 12.60% 12.43% 12.29% 12.16% 12.05% 11.95% a) If the existing policy of paying \$ 50 million in dividends is continued. Current 1 2 3 4 5 Debt 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ Equity 5,000.00 \$ 5,680.00 \$ 6,435.65 \$ 7,275.37 \$ 8,208.50 \$ 9,245.45 \$ D/(D+E) 50.00% 46.82% 43.72% 40.73% 37.85% 35.10% D/E 100.00% 88.03% 77.69% 68.73% 60.91% 54.08% Dividends - \$ - \$ - \$ - \$ - \$ - \$ Beta 1.20 1.15 1.10 1.06 1.02 0.99 Expected Retur 13.60% 13.30% 13.05% 12.83% 12.63% 12.46% Dividend Yield 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Exp. Price App 13.60% 13.30% 13.05% 12.83% 12.63% 12.46% Problem 4 a. Current Return on Capital= EBIT(1-t)/(BV:D+E) = 300 (1-.4) / (1000 + 2000) = 6.00% Current Cost of Equity = 7% + 1.30 (5.5%) = 14.15% Cost of Capital = 14.15% (4000/5000) + 8% (1-.4) (1000/5000) = 12.28% Given that the return on capital is less than the cost of capital, DGF Corporation should try to increase its debt ratio by buying back stock or paying dividends, unless it expects future projects to earn more than its] expected cost of capital (11.28%) - i.e, 1% less than the current cost of capital. b. I would consider future investment opportunities and the volatility of operating income in making this decision. If I expect future projects to be better than existing projects, I would be more inclined towards recommending borrowing money / taking projects. Page 2
Capital Structure Changes Problem 5 To advice STL Corporation on designing debt, I would need to get information on the types of assets/projects that they plan to finance with the debt.

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## This note was uploaded on 01/29/2012 for the course ECONOMICS 3400 taught by Professor Kroger during the Spring '11 term at Georgia State.

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capstap1 - Capital Structure Changes Problem 1 a There are...

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