Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The company’s EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firm’s owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm’s investment banker the following estimated costs of debt for the firm at different capital structures: Percent financed: w/Debt rd 0% - 20 8.0% 30 8.5 40 10.0 50 12.0 If the company were to recapitalize, then debt would be issued and the funds received would be used to repurchase stock. Pizza Palace is in the 40 % state-plus-federal corporate tax bracket,its beta is1.0, the risk-free rateis 6% and the market risk premium is 6%
Assignment: Write a 250-500-word recommendation of the financial decision you propose for this company based on an analysis of its capital structure and capital budgeting techniques.