In: Finance
Capital Structure Analysis
The Rivoli Company has no debt outstanding, and its financial
position is given...
Capital Structure Analysis
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.
- What effect would this use of leverage have on the value of the
firm?
I. Increasing the financial leverage by adding
debt results in a decrease in the firm's value.
II. Increasing the financial leverage by adding
debt has no effect on the firm's value.
III. Increasing the financial leverage by adding
debt results in an increase in the firm's value.
-Select-IIIIIIItem 1
- What would be the price of Rivoli's stock? Do not round
intermediate calculations. Round your answer to the nearest
cent.
$ per share
- What happens to the firm's earnings per share after the
recapitalization? Do not round intermediate calculations. Round
your answer to the nearest cent.
The firm -Select-increaseddecreasedItem 3 its EPS by
$ .
- The $500,000 EBIT given previously is actually the expected
value from the following probability distribution:
Probability |
EBIT |
0.10 |
($ 120,000) |
0.20 |
250,000 |
0.40 |
350,000 |
0.20 |
850,000 |
0.10 |
1,520,000 |
Determine the times-interest-earned ratio for each probability. Use
a minus sign to enter negative values, if any. Do not round
intermediate calculations. Round your answers to two decimal
places.
Probability |
TIE |
0.10 |
|
0.20 |
|
0.40 |
|
0.20 |
|
0.10 |
|
What is the probability of not covering the interest payment at the
40% debt level? Do not round intermediate calculations. Round your
answer to two decimal places.
%