In: Finance
The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
Assets (Market value = book value) | $3,000,000 |
EBIT | $500,000 |
Cost of equity, rs | 10% |
Stock price, Po | $15 |
Shares outstanding, no | 200,000 |
Tax rate, T (federal-plus-state) | 40% |
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 40% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.
Probability | EBIT |
0.10 | ($ 120,000) |
0.20 | 250,000 |
0.40 | 350,000 |
0.20 | 850,000 |
0.10 | 1,520,000 |
Probability | TIE |
0.10 | |
0.20 | |
0.40 | |
0.20 | |
0.10 |