Problem: You have been asked to analyze the capital structure of DASA Inc, and make recommendations on a future course of action. DASA Inc. has 40 million shares outstanding, selling at $20 per share and a debt-equity ratio (in market value terms) of 0.25. The beta of the stock is 1.15, and the firm currently has an AA rating, with a corresponding market interest rate of
10%. The firm's income statement is as follows:
EBIT $150 million
Interest Exp. $ 20 million
Taxable Inc. $130 million
Taxes $ 52 million
Net Income $ 78 million
The current riskfree rate is 8% and the market risk premium is 5.5%.
Question 1. What is the firm's current weighted average cost of capital? (25 points)
Question 2. The firm is proposing borrowing an additional $200 million in debt and repurchasing stock. If it does so its rating will decline to A, with a market interest rate of 11%. What will the Weighted average cost of capital be if they make this move?
Question 3. What will the new stock price be if they borrow $200 million and repurchase stock (assuming rational investors)?
Question 4. Now assume that the firm has another option to raise its debt/equity ratio (instead of borrowing money and repurchasing stock). It has considerable capital expenditures planned for the next year ($150 million). The company also pays $1 in dividends per share currently (Current Stock Price=$20). If the company finances all its capital expenditures with debt and doubles its dividend yield from the current level for the next year, what would you expect the debt/equity ratio to be at the end of the next year?