In: Finance
Lowell Inc. has no debt and its financial position is given
by
the following data:
Assets (book = market) $3,000,000
EBIT $500,000
Cost of equity (Ks) 10%
Stock price (P0) $15
Shares outstanding n0 200,000
Tax rate T 40%
The firm is considering selling bonds and simultaneously
repurchasing some of its stock. It if moves to capital
structure
with 30 percent debt based on market values, its cost of
equity,
Ks, will increase to 11 percent to reflect the increased
risk.
Bonds can be sold at a cost (Kd) of 7 percent. Lowell Inc. is
a
no-growth firm. Hence, all its earnings are paid out as
dividends, and earnings are exceptionally constant over time.
a. What would be the new WACC?
b. What effect would this use of leverage have on the value of
the
firm (Va)?
c. What would be Lowell Inc.’s stock price?
d. What happens to the firm’s earnings per share after the
recapitalization?