1) Sunshine a manufacturer of consumer plastic products is estimating its capital structure. Book value balance sheet of company is given below: (all numbers in millions)
Assets Liabilities
Current Assets $1000 Debt $2500
Net Fixed Assets $4000 Equity $2500
Total $5000 $5000
In addition, you are provided the following information
i) The debt of company is long-term bonds, coupon rate is 10%. Bonds are presently rated AA with the Yield to Maturity of 12%. The market value bond is 80% of par.
ii) Firm presently has 50 million shares outstanding, present market price per share is $80. Firm pays a dividend of $4 per share, and has P/E ratio of 10.
iii) Stock presently has the β of 1.2. T-Bond rate is 8%.
iv) Firm’s tax rate is .40
2) Moonstar is considering a main change in its capital structure. Firm plans to issue $3 billion in new debt and buy back stock. This will cause the firm’s debt rating to fall to CCC. (CCC debt yields 18% in the market).
a) Determine the cost of equity after this change takes place.
b) Determine the firm’s WACC.
c) Supposing there is no cost of financial distress imposed on the firm, determine the new share price?
d) Explain how the cost of financial distress might affect this firm.