Mercer Corp. is a equity firm with 10 million shares outstanding and $140 million worth of debt outstanding. Its current share price is $76. Mercer's equity cost of capital is 8.5%. Mercer has just announced that it will issue $361 million worth of debt. It will use the proceeds from this debt to pay off its existing debt, and use the remaining $221 million to pay an immediate dividend. Assume perfect capital markets. a. Estimate Mercer's share price just after the recapitalization is announced, but before the transaction occurs. b. Estimate Mercer's share price at the conclusion of the transaction. (Hint: use the market value balance sheet.) c. Suppose Mercer's existing debt was risk-free with a 4.42% expected return, and its new debt is risky with a 4.85%expected return. Estimate Mercer's equity cost of capital after the transaction.

Mercer Corp. is a equity firm with 10 million shares outstanding and $140 million worth of debt outstanding. Its current share price is $76. Mercer's equity cost of capital is 8.5%. Mercer has just announced that it will issue $361 million worth of debt. It will use the proceeds from this debt to pay off its existing debt, and use the remaining $221 million to pay an immediate dividend. Assume perfect capital markets. a. Estimate Mercer's share price just after the recapitalization is announced, but before the transaction occurs. b. Estimate Mercer's share price at the conclusion of the transaction. (Hint: use the market value balance sheet.) c. Suppose Mercer's existing debt was risk-free with a 4.42% expected return, and its new debt is risky with a 4.85%expected return. Estimate Mercer's equity cost of capital after the transaction.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Sierra Vista Industries (SVI) wishes to estimate its cost of capital for the use in the analyzing projects that are similar to those that already exist. The firm’s current capital structure in terms of market value includes 40 percent debt, 10 percent preference shares and 50 percent ordinary shares. The firm’s debt has as average yield to maturity of 8.3 percent. Its preference shares have a GH¢ 70 par value, an 8 percent dividend, and are currently selling for GH¢ 76 per share. SVI’s beta is 1.05, risk-free rate is 4 percent and return on the S&P 500 (the market proxy) is 11.4 percent. SVI is in the 40 percent marginal tax bracket. 1. what are SVI’s pre-tax costs of debt, preference shares and ordinary shares? 2. Calculate SVI’s weighted average cost of capital (WACC) on both a pre-tax and an after-tax basis. Which WACC should SVI use when making investment decisions? 3. SVIS is contemplating a major investment that is expected to increase both its operation and financial…
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Kennedy Limited is an all-equity publicly listed firm with 600,000 shares currently on issue trading at $20 per share and is expected to generate $1,800,000 in EBIT p.a. in perpetuity. They are considering immediately repurchasing one third their equity at the current market price and replacing this with debt with an interest cost of 4% per annum. Assume that Kennedy Limited operate in a perfect capital market with no taxes, information costs, transaction costs etc. a) Demonstrate the impact of the change in capital structure on the (i) Net Income, (ii) ROE and (iii) ROA for Kennedy Limited. b) For what value of EBIT will ROE be unaffected by Kennedy Ltd’s decision to repurchase shares?
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