Question
In: Finance
A consultant has collected the following information regarding a company: Total Assets= 4,000 Million Tax Rate=...
A consultant has collected the following information regarding a company:
|
Total Assets= 4,000 Million |
Tax Rate= 40% |
|
Operating Income (EBIT)= 800 Million |
Debt Ratio= 0% |
|
Interest expense= 0 Million |
WACC (return on asset)= 10% |
|
Net Income= 480 Million |
EPS=Dividend= $4.50 |
|
Share Price= $40 |
The company has no growth opportunities (g=0), so the company pays out all of its earnings as dividends (EPS=DPS). The stock price can be calculated by simply dividing earnings per share by the required rate of return on equity capital, which currently equals the WACC because the company has no debt. The consultant believes that the company would be much better off it is were to change its capital structure to 50% debt and 50% equity. After meeting with investment bankers, the consultant concludes that the company could issue 2000 million of debt at a cost of 8%, leaving the company with interest expense of 160 million. The 2000 million raised from the debt issue would be used to repurchase stock at $40 per share. How many shares will be repurchased? The repurchase will have no effect on the firm's EBIT however, after the repurchase, the cost of equity will increase to 11%. Calculate the Net Income after the debt issue. If the firm follows the consultant's advice, what will be its estimated stock price after the capital structure change?
Solutions
Expert Solution
There seems to be a problem in the question , EPS given doesn't seem right that's why I have calculated the same again below -
| Income Statement | ||
| Particulars | Current | Proposed |
| EBIT | $ 800,000,000.00 | $ 800,000,000.00 |
| Interest | $ - | $ 160,000,000.00 |
| EBT | $ 800,000,000.00 | $ 640,000,000.00 |
| Tax | $ 320,000,000.00 | $ 256,000,000.00 |
| EAT | $ 480,000,000.00 | $ 384,000,000.00 |
| No. of Shares | 120000000 | 70000000 |
| EPS | $ 4.00 | $ 5.49 |
| WACC | 10% | 7.9% |
| Price per share | $ 40.00 | $ 69.44 |
| 1. Number of shares that would be repurchased | ||
| Amount to be raised/ price per share | ||
| $2000000000/$40 | = | 50000000 |
| 2. Net Income after debt issue | ||
| As calculated above = | $ 384,000,000.00 | |
| 3. Price per share after restructuring | ||
| As calculated above = | $ 69.44 | |
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