First Pacific Company is an all-equity firm with earnings expected to be $900,000 annually in perpetuity. The firm has 200,000 shares outstanding. The weighted average cost of capital (WACC) is 12%. First Pacific Company is considering a major expansion of facilities. This expansion will require an initial outlay of $800,000, which is expected to produce additional annual earnings of $300,000 per year in perpetuity. The management of First Pacific Company considers the expansion to have the same risk as the firm’s existing assets (Hints: No taxes and no costs of bankruptcy.)
a. What is the current price per share of First Pacific Company?
b. Assume First Pacific Company plans to finance the expansion by issuing common stock. How many shares must be issued? In this case, what is the price per share of the stocks?
c. If First Pacific Company plans to finance the expansion by issuing bonds with an interest rate of 11%, what will be the the firm’s value after the bond issue? Under this scenario, what will be the price per share?
d. After paying interest for the equity holders, what will be the expected yearly income? Use the expected yearly income and measure the expected return for the equity holders.
e. Use M&M Proposition II (no taxes) to determine the expected return for the equity holders.