Nelco Inc. has decided in favour of a capital structuring that involves increasing its existing $80 million in debt to $125 million. The interest rate on debt is 9% and is not expected to change. The firm currently has 10 million shares outstanding and the price per share is $45. If the restructuring is expected to increase the ROE, what is the minimum level of EBIT that Nelco’s management must be expecting. Ignore taxes in your answer.
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Question 3
Nelco Inc. has decided in favour of a capital structuring that involves
increasing its existing $80 million in debt to $125 million. The interest
rate on debt is 9% and is not expected to change. The firm currently has 10
million shares outstanding and the price per share is $45. If the
restructuring is expected to increase the
EBIT that Nelco’s management must be expecting. Ignore taxes in your answer.
Step by step
Solved in 3 steps
- 2. Business and financial risk The impact of financial leverage on return on equity and earnings per share Consider the following case of Purple Panda Importers: Suppose Purple Panda Importers is considering a project that will require $350,000 in assets. • The company is small, so it is exempt from the interest deduction limitation under the new tax law. • The project is expected to produce earnings before interest and taxes (EBIT) of $60,000. • Common equity outstanding will be 25,000 shares. • The company incurs a tax rate of 25%. If the project is financed using 100% equity capital, then Purple Panda Importers's return on equity (ROE) on the project will be addition, Purple Panda's earnings per share (EPS) will be Alternatively, Purple Panda Importers's CFO is also considering financing the project with 50% debt and 50% equity capital. The company's debt will be 10%. Because the company will finance only 50% of the project with equity, it will have only 12,500 shar Panda…Part 2 (Continuation) Sayote Corporation is considering changing its capital structure in order to lower its cost of capital and raise firm value. Sayote currently has a capital structure that is 20 percent debt and 80 percent equity based on market values. (It has a D/E ratio of 0.25.) The risk-free rate is 7%, and the business risk premium is 5%. The company's current cost of equity, calculated using the CAPM, is 14%, and its tax rate is 35%. What will Sayote's estimated cost of equity be if it changed its capital structure to 50% debt and 50% equity? Compute for the new levered beta using the new capital structure.(Hint: Find the firm's new cost of equity given the new levered beta) * Your answerQuestion 1 Bloom Company Limited expects its EBIT to be $80,000 every year forever. The firm can borrow at 9 percent. The firm currently has no debt, and its cost of equity is 13 percent. The tax rate is 35 percent. The firm will borrow $100,000 and use the proceeds to repurchase shares. You are required to answer the following: (a) What is the value of the unlevered firm? (b) What will be the value of firm after recapitalization? (c) What is the value of equity in the recapitalized firm? (d) What is the Weighted Cost of Capital of the levered firm?
- Give typing answer with explanation and conclusion Suppose that Rose Industries is considering the acquisition of another firm in its industry for $100 million. The acquisition is expected to increase Rose's free cash flow by $5 million the first year, and this contribution is expected to grow at a rate of 3% every year there after. Rose currently maintains a debt to equity ratio of 1, its marginal tax rate is 40%, its cost of debt rD is 6%, and its cost of equity rE is 10%. Rose Industries will maintain a constant debt-equity ratio for the acquisition. Rose's unlevered cost of capital is closest to: 9.0% 8% 7.0% 7.5%Part 1-Sayote Corporation is considering changing its capital structure in order to lower its cost of capital and raise firm value. Sayote currently has a capital structure that is 20 percent debt and 80 percent equity based on market values. (It has a D/E ratio of 0.25.) The risk-free rate is 7%, and the business risk premium is 5%. The company's current cost of equity, calculated using the CAPM, is 14%, and its tax rate is 35%. What will Sayote's estimated cost of equity be if it changed its capital structure to 50% debt and 50% equity? Compute for the new levered beta using the new capital structure. * Your answerQuestions 1 Maynard Inc. has no debt outstanding and a total market value of $250,000. EBIT are projected to be $28,000 if the economic condition is normal. If there is a strong expansion in the economy. then EBIT will be 30% higher. If there is a recession, then EBIT will be 50% lower. Maynard is considering a $90,000 debt issue with a 7% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding. Ignore taxes for this problem. A. Calculate EPS under each of the 3 economic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enter recession. B. Repeat part (a) assuming that the economy goes through with recapitalization. What do you observe? C. Repeat parts a and b in ex. 1 assuming Maynard has a tax rate of 35%.
- 5 1. The JJ. Binks Company is an all equity firm. It expects perpetual earnings before interest and taxes (EBIT) of $120 million per year. Its equity required return is 15%. The firm is subject to a 25% tax rate. a. Calculate the value of the un-levered JJ. Binks? b. The company considers leveraging as a way to increase the firm value. With leveraging it will face bankruptcy possibility at a cost of $60 million in exactly one year (Assume a 15% discount rate). The company plans to issue debt and buy back shares with the proceeds. It considers the following debt issuance: $50m, $75m , $100m, 125m, 150m and 175m. These debt levels will introduce an increasing probability financial distress of 5%, 10%, 20%, 30%, 50% and 70%, respectively. Evaluate the JJ. Binks optimal capital structure.H5. A cmpany's tax rate is 40%, its beta is 1.20, and it uses no debt. However, the CFO is considering moving to a capital structure with 25% debt and 75% equity. If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity? Show proper calculationQuestions 2 Maynard Inc. has no debt outstanding and a total market value of $ 250,000. Earnings before interest ana taxes, EBIT, are projected to be $ 28,000 if economi conditions are normal. If there is strong expansion in the economy, then EBIT will be 30% higher. If there is a recession, then EBIT will be 50% lower. Maynard is considering a $ 90,000 debt issue with a 7% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding. Ignore taxes for this problem. Suppose the company has a market-to-book ratio 1.0 a. Calculate return of equity (ROE) under each of the three economic scenarios before any debt issued. Also calculate the percentage changes in ROE for economic expansion dan recession, assuming no taxes b. Repeat Part (a) assuming the firm goes through with the proposed recapitalizatio C. Repeat Part (a) and (b) of this problem assuming the firm has a tax rate of 35 percent
- 5. Business and financial risk Aa Aa The impact of financial leverage on return on equity and earnings per share Consider the following case of Lost Pigeon Aviation: Suppose Lost Pigeon Aviation is considering a project that will require $200,000 in assets. The project is expected to produce earnings before interest and taxes (EBIT) of $40,000. Common equity outstanding will be 25,000 shares. The company incurs a tax rate of 35%. If the project is financed using 100% equity capital, then Lost Pigeon Aviation's return on equity (ROE) on the project will be In addition, Lost Pigeon's earnings per share (EPS) will be Alternatively, Lost Pigeon Aviation's CFO is also considering financing the project with 50% debt and 50% equity capital. The interest rate on the company's debt will be 12%. Because the company will finance only 50% of the project with equity, it will have only 12,500 shares outstanding. Lost Pigeon Aviation's ROE and the company's EPS will be if management decides to…Part 1-Sayote Corporation is considering changing its capital structure in order to lower its cost of capital and raise firm value. Sayote currently has a capital structure that is 20 percent debt and 80 percent equity based on market values. (Ilt has a D/E ratio of 0.25.) The risk-free rate is 7%, and the business risk premium is 5%. The company's current cost of equity, calculated using the CAPM, is 14%, and its tax rate is 35%. What will Sayote's estimated cost of equity be if it changed its capital structure to 50% debt and 50% equity? Compute for the new levered beta using the new capital structure. * Your answer Part 2 (Continuation) Sayote Corporation is considering changing its capital structure in order to lower its cost of capital and raise firm value. Sayote currently has a capital structure that is 20 percent debt and 80 percent equity based on market values. (It has a D/E ratio of 0.25.) The risk-free rate is 7%, and the business risk premium is 5%. The company's current…H3. The value of HILEV firm at the end of one year can be $50 m or $100 m with equal probability of 0.5. The firm has debt with a face value of $50 m that matures in one year. Assume that investors are risk-neutral and the risk free rate is zero. The CEO of the firm decides to substitute assets of the firm with more risky assets immediately, so that the value of the firm at the end of one year is either $30 m or $120 m with equal probability of 0.5. This asset substitution will lead to A. A gain of $10 million for stockholders and a loss of $10 million for bondholders B. A loss of $10 million for stockholders and a gain of $10 million for bondholders C. No gain or loss to debtholders or equity holders D. Both debtholders and equity holders will lose $10 million from the increased risk of the business Show proper step by step calculation