Question 1- Capital Structure
Pennewell Publishing Inc. (PP) is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT) are $80,000. PP's current cost of equity is 10i, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $54.00.
a) PP is considering changing its capital structure to one with 40% debt and 60% equity, based on market values. The debt would have an interest rate of 8%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the added leverage would cause the required rate of return on equity to rise to 12%. If this plan were carried out, what would be PP's new value of operations?
b) Now assume that PP is considering changing from its original capital structure to a new capital structure with 40% debt and 60% equity. This results in a weighted average cost of capital equal to 9.0% and a new value of operations of $533,333. Assume PP raises $200,000 in new debt and purchases T-bills to hold until it makes the stock repurchase. What is the stock price per share immediately after issuing the debt but prior to the repurchase?
c) Assume that PP is considering changing from its original capital structure to a new capital structure with 35$ debt and 65% equity. This results in a weighted average cost of capital equal to 9.0% and a new value of operations of $533,333. Assume PP raises $200,000 in new debt and purchases T-bills to hold until it makes the stock repurchase. PP then sells the T-bills and uses the proceeds to repurchase stock. How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase?
Question 2- Capital Structure
Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $600,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
a) What is the value of the firm according to MM with corporate taxes?
b) What is the firm's cost of equity?
c) Assume that the firm's gain from leverage according to the Miller model is $130,000. If the effective personal tax rate on stock income is Ts = 20%, what is the implied personal tax rate on debt income?
Question 3. Residual model, NI, divs and payout
a: The capital budget forecast for the Santano Company is $700,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $450,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?
b: United Builders wants to maintain a target capital structure with 35% debt and 65% equity. Its forecasted net income is $520,000, and because of market conditions, the company will not issue any new stock during the coming year. If the firm follows the residual dividend policy, what is the maximum capital budget that is consistent with maintaining the target capital structure?
c Brinkley Resources stock has has increased significantly over the last five years, selling now for $1200 per share. Management feels this price is too high for the average investor and wants to get the price down to a more typical level, which it thinks is $150 per share. What
stock split would be required to get to this price, assuming the transaction has no effect on the total market value? Put another way, how many new shares should be given per one old share?
Question 4- Refunding Analysis
Five years ago, Northwest Water (NWW) issued $70,000,000 face value of 30-year bonds carrying a 12% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.00% in today's market. A call premium of 12% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
a) What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?
b) What will the after-tax annual interest savings for NWW be if the refunding takes place?
c) The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?
d) What is the NPV if NWW refunds its bonds today?
Question 5- Lessee's analysis
Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $80,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 8%, and the.loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $12,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,500 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 30%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)
Question 6 - Convertible Bonds and warrants
a) Preissle Company, wants to sell some 20-year, annual interest, $1,000 par value bonds. Its stock sells for $42 per share, and each bond would have 50 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 8%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. what coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?
b) The following data apply to Neuman Corporation's convertible bonds:
Maturity: 10 Stock price: $20.00
Par value: $1,000.00 Conversion price: $25.00
Annual coupon: 5.00% Straight-debt yield: 7.00%
1) What is the bond's conversion ratio?
ii) What is the bond's conversion value?
iii) What is the bond's straight-debt value?
iv) Based on your answers to the three preceding questions, what is the minimum price (or "floor" price) at which the Neuman's bonds should sell?