Capital structure analysis: the ravioli company has no debt outstanding, and its financial position is giving by the following data:
Assets (book=market) $3,000,000
EBIT $500,000
Cost of equity, rs 10%
Stock price, P0 $15
Shares outstanding, n0 200,000
Tax rate, T (federal-plus-state) 40%
The firm is considering selling bond and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% dept. based on market values, its cost of equity, rs, will increase to 11%, to reflect the increase risk. Bonds can be sold at a cost, rd, of 7%. Ravioli is a no growth firm. Hence, all it's earning are paid out as dividends. Earnings are expected to be constant over time.
a- What effect would this use of leverage have no the value of the firm?
b- What would be the price of ravioli's stock?
c- What happens to the firm's earning per share after the recapitalization?
d- the $ 500,000 EBIT giving previously is actually the expected value from the following probability distribution:
Probability EBIT
.10 ($ 100,000)
.20 200,000
.40 500,000
.20 800,000
.10 1,100,000
Determine the times- interest- earned ratio for each probability. What is the probability of not covering the interest payment at the 30% debt level?