An all-equity cash-rich company is considering the following change in capital structure:
borrow $50 million at an interest rate of 6.75%
Use the loan together with $209 million of its own cash to repurchase 14 million shares at the current market price of $18.50/share
Currently, the (market value) balance sheet and the income statement of the company. Are as follows (expressed in $ thousands) :
Assets Liabilities
Cash $230,866 Debt $0
Other Assets $257,497 Equity $488,363
Total $488,363 Equity $488,363
Revenue $346,366
Less: Cost of Goods Sold $249,794
Gross Profit $96,572
Less: Selling, General & Administrative Expenses $28,512
EBIT $68,060
Earnings Before Tax $68,060
Less: Taxes $23,821
Net Income $44,239
Dividends $28,345
Questions:
1. Create the pro-forma balance sheet and income statement taking into account the proposed change in the capital structure, assuming the tax regime and payout policy (in terms of percentage of net income paid out as dividends) remain unchanged
2. Calculate the dividends per share for the current and proposed capital structure and discuss how capital structure affects the cash flows to shareholders
3. Discuss the benefits and costs of higher leverage
4. What are the costs of financial distress of the firm before the proposed share re-purchase? How do you expect them to change with leverage? Why?