M&M Pies has no debt in its capital structure. Current market price per share is $80 for it's 195,000 shares. The managers of M&M Pies are considering doing a financial restructuring to add debt to the firm's capital structure. No changes are planned on the operating side of the firm, so EBIT is expected to remain the same at $2,392,000, with a 100% dividend payout ratio. The firm can issue new debt at a yield of 7%. The corporate tax rate is 25%. Ignore issuing costs. Three alternative capital structures are under consideration:
|
Case
|
1
|
2
|
3
|
|
Debt issued
|
$0
|
$1,000,000
|
$2,000,000
|
A. What is the firm value under each alternative?
B. What is the total value of equity under each alternative?
C. What is the price per share of equity under each alternative?
D. What is the cost of equity under each alternative?
E. Which capital structure gives the lowest WACC. Show calculations.
F. Which capital structure is the best choice? Why?
(I want an argument/explanation based upon concepts from the course, not a calculation.)