Question

Mason's Co currently has EBIT of $65,000 and is a zero growth company. It has $150,000 (book value) of perpetual debt outstanding carrying a coupon rate of 7% and a current market price of 101.2. Smith's current cost of equity is 9.3%, and its tax rate is 21%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00. Please show all calculations.

a. What is Mason's current total market value and weighted average cost of capital?

b. The firm is considering moving to a capital structure that is comprised of 40% debt and 60% equity, based on market values. The new funds would be used to replace the old debt and to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on debt to rise to 8.2%, while the required rate of return on equity would rise to 9.7%. If this plan were carried out, what would be Smith's new WACC and total value?

c. Now assume that Mason's is considering changing from its original capital structure to a new capital structure that results in a stock price of $62 per share. The resulting capital structure would have a $336,000 total market value of equity and a $504,000 market value of debt. How many shares would Mason's repurchase in the recapitalization? (Round to the nearest whole share.)

d. Now assume that Mason's is considering changing from its original capital structure to a new capital structure with 60% debt and 40% equity. If it makes this change, its resulting market value would be $720,000. What would be its new stock price per share?

Answer 1