Question

Exhibit 16.1 CSUSM is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT) are $80,000. CSUSM 's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.

11.Refer to Exhibit 16.1. CSUSM is considering changing its capital structure to one with 30% debt and 70% equity, based on market values. The debt would have an interest rate of 8%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the added leverage would cause the required rate of return on equity to rise to 12%. If this plan were carried out, what would be CSUSM 's new value of operations?

12.Refer to Exhibit 16.1. Assume that CSUSM is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity. This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638. Assume CSUSM raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase. What is the stock price per share immediately after issuing the debt but prior to the repurchase?

13.Refer to Exhibit 16.1. Assume that CSUSM is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity. This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638. Assume CSUSM raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase. PP then sells the T-bills and uses the proceeds to repurchase stock. How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase?

Answer 1

Answer : 11

Calculation of CSUSM 's New value of Operation :

For the purpose of Calculation of New Value of Operation we need to first calculate new WACC

Given :

Debt value ( Wd) = 30% or 0.30

Equity Value ( We)= 70% or 0.70

Cost of Debt ( Kd) =8%

New cost of equity (Ke) =12%

WACC =Kd(1-T) * Wd + Ke* We

WACC =[8%(1-0.40) * 0.30] + [12% * 0.70]

= [4.80% * 0.30 ] + [8.4 %]

= 1.44% + 8.4%

= 9.84 %

Given EBIT = $ 80,000

Tax rate = 40%

Currently the company has no growth. Therefore growth rate is 0 %

Value of New Operation =FCF / WACC

=EBIT (1-T) / WACC

=$80,000 (1-0.40)/ 9.84%

= $ 487,804.88

Answer 12 :

New Debt Value = 35 %

New Equity Vlue = 65 %

WACC = 9.4%

New Value of Operation = $ 510,638.

Calculation of Stock price per share immediately after issuing the debt but prior to the repurchase:

First step is to calculate Total Value

Total value = New value of operations + Value of new debt

Total value = 510,638 + 178,723

Total value = $ 689,361

Now we need to calculate Value of Equity

Value of equity = Total value - Value of new debt

Value of equity = 689,361 - 178723

Value of equity = $510,638

Price per share = Values of equity / Number of shares outstanding

= 510638 / 10,000

= 51.0638

Answer : 13

Calculation of Shares remaining after repurchase

Shares Repurchased = Old Debt / Price per share as calculated in part b.

   = 178,723 / 51.0638

  = 3500

Shares remaining After Repurchase = 10,000 - 3500 = 6500 shares

Calculation of stock price per share immediately after the repurchase

Equity value = New value of operations - Value of new debt

= 510,638 - 178,723

= $ 331,915

Price per share = Total Equity value / No. of shares after repurchase

= 331,915 / 6,500

= $51.0638