Question

QUESTION 42

1. Pennewell Publishing Inc. (PP)

   Pennewell Publishing Inc. (PP) is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT) are $80,000. PP's current cost of equity is 10%, and its tax rate is 25%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.

   Refer to the data for Pennewell Publishing Inc. (PP). PP 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 PP's new value of operations?

   	a.	$648,529
   	b.	$588,235
   	c.	$552,941
   	d.	$617,647
   	e.	$680,956

QUESTION 45

1. Best Bagels, Inc. (BB)

   Best Bagels, Inc. (BB) currently has zero debt. Its earnings before interest and taxes (EBIT) are $130,000, and it is a zero growth company. BB’s current cost of equity is 13%, and its tax rate is 25%. The firm has 30,000 shares of common stock outstanding selling at a price per share of $25.

   Refer to the data for Best Bagels, Inc. (BB). Now assume that BB is considering changing from its original capital structure to a new capital structure with 40% debt and 60% equity. This results in a weighted average cost of capital equal to 11.7% and a new value of operations of $833,333. Assume BB raises $333,333 in new debt and purchases T-bills to hold until it makes the stock repurchase. BB 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?

   Remaining shares; Stock price after repurchase

   	a.	18,000; $27.78
   	b.	23,500; $35.71
   	c.	21,800; $34.34
   	d.	20,800; $31.51
   	e.	19,400; $29.44

QUESTION 47

1. Morales Publishing's tax rate is 25%, its beta is 1.10, and it uses no debt. However, the CFO is considering moving to a capital structure with 30% debt and 70% equity. If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?

   	a.	1.91%
   	b.	2.57%
   	c.	2.33%
   	d.	2.12%
   	e.	2.82%

Answer 1

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