1. Greenwave, Inc., went public 5 years ago and has had no further equity issuance (or repurchases of equity). The firm has the following current balances for its book value of equity:
Par Value ($2.00 par value per share) $350,000
Capital in Excess of Par $0
Retained Earnings $7,800,000
a. From this information, can we tell how many shares are outstanding for this firm and the price that these shares were sold to the publiV If so, calculate these two items. If not, tell me what additional information you need to know.
b. What is Greenwave's Book Value Per Share?
c. Can the Greenwave's market value per share be calculated using the above information? Explain why or why not.
d. Calculate what the new Book Value Per Share would be if the firm decided to issue another 40,000 shares at $20 per share.
2. Pretend that it is now January 1, 2009. Clamato, Inc. has issued cumulative preferred stock with an annual 10% dividend and a par value of $25 per share. They also have common stock outstanding that has historically paid a $0.06 per share dividend.
a. How many dollars are expected to be paid out as a preferred stock dividend (per share) in 2009?
b. Suppose that next year (2010) that Clamato experiences some cash flow problems and for the first time ever, the company decides not to pay their preferred and common stock dividends. One year later, (2011), the firm wishes to pay a $0.07 per share common stock dividend. How much will the company pay to an investor that holds one share of common stock and one share of preferred stock in 2011?
c. If the investor is a U.S. individual with a large ownership in Clamato, Inc., what percent of the preferred stock dividend will be taxable, according to the U.S. tax code?
d. If the investor is a U.S. corporation with a small ownership in Clamato, what percent of the preferred stock dividend will be taxable, according to the U.S. tax code?
3. Firenze, Inc. is an all-equity firm that has 500,000 shares of stock outstanding. The company has decided to borrow $8 million at 9% interest to repurchase 200,000 shares of outstanding stock.
a. Suppose that Firenze operates without taxation (or financial distress). What is the value of this firm in its current all-equity state, What will the firm's value be after the recapitalization?
b. Under MMI, in a world with no taxes (nor financial distress), would the value of the levered firm above (i.e. Firenze with $8 million of debt after the recapitalization) increase or decrease if only $4 million was borrowed to buy back 100,000 shares of stock? Explain your answer.
4. Ignore taxes and financial distress for this question. Suppose that your firm has a debt-equity ratio of 0.75, a cost of debt of 8,5%, and an unlevered cost of equity of 15%.
a. What is your firm's cost of equity and WACC?
b. If you decrease your DiE ratio to 0.50, what would your cost of equity and WACC be? Assume that your cost of debt stays at 8.5%, regardless of your debt burden.
5. Bourbon Street, Inc. has debt of $3,000 (face and market value). This debt has a coupon rate of 7% and pays interest annually. The expected annual earnings before interest and taxes is $1,200, the tax rate is 34%, and the unlevered cost of capital is 12%. What is the firm's cost of equity?
6. (Ignore financial distress for this question) Pisa Corporation is currently an all-equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the tax rate is 34%. Pisa's management is considering adding $1 million of debt with a coupon rate of 8% to the capital structure and using the money to repurchase stock. The debt will be sold at par.
a. What is your estimate of the new levered value of the firm?
b. Now increase the debt used to repurchase stock to $3 million. What is the value of the levered firm now? Why does the value of the firm change, if at all, from your answer to part (a)?
c. Compare your answers in parts (a) and (b). What does this say about the optimal capital structure for a firm in a world of taxes (but no financial distress)?
7. A firm has zero debt in its capital structure. Its overall cost of capital is currently 9%. The firm is considering a new capital structure with 40% debt. The interest rate of the debt would be 4% no matter what amount of debt is taken on.
a. Assuming that the corporate tax rate is 34%, what would be the firm's cost of equity and WACC with the new capital structure?
b. Now increase the new capital structure to a EVE ratio of 2.333333, What would the cost of equity be now? What about the WACC?
c. Why does the cost of equity and the WACC change, if at all, from part (a) to part (b)?
8. Is there an easily identifiable debt-equity ratio that will maximize the value of a firm in a world with taxes and financial distress? Why or why not?