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

Related Solutions

The Sooner Equipment Company has total assets of $100 million. Of this total, $45 million was...
The Sooner Equipment Company has total assets of $100 million. Of this total, $45 million was financed with common equity and $55 million with debt (both long and short-term). Its average accounts receivable balance is $24 million, and this represents an 80-day average collection period. Sooner believes it can reduce its average collection period from 80 to 65 days without affecting sales or the dollar amount of net income after taxes (currently $4.5 million). What will be the effect of...
The Sooner Equipment Company has total assets of $110 million. Of this total, $40 million was...
The Sooner Equipment Company has total assets of $110 million. Of this total, $40 million was financed with common equity and $70 million with debt (both long and short-term). Its average accounts receivable balance is $24 million, and this represents an 80-day average collection period. Sooner believes it can reduce its average collection period from 80 to 60 days without affecting sales or the dollar amount of net income after taxes (currently $6 million). What will be the effect of...
The Sooner Equipment Company has total assets of $110 million. Of this total, $40 million was...
The Sooner Equipment Company has total assets of $110 million. Of this total, $40 million was financed with common equity and $70 million with debt (both long and short-term). Its average accounts receivable balance is $24 million, and this represents an 80-day average collection period. Sooner believes it can reduce its average collection period from 80 to 60 days without affecting sales or the dollar amount of net income after taxes (currently $6 million). What will be the effect of...
The Sooner Equipment Company has total assets of $90 million. Of this total, $40 million was...
The Sooner Equipment Company has total assets of $90 million. Of this total, $40 million was financed with common equity and $50 million with debt (both long and short-term). Its average accounts receivable balance is $20 million, and this represents an 85-day average collection period. Sooner believes it can reduce its average collection period from 85 to 65 days without affecting sales or the dollar amount of net income after taxes (currently $4.71 million). What will be the effect of...
ABC has accumulated $23 million in assets, operating income of $1.75 million. The tax rate is...
ABC has accumulated $23 million in assets, operating income of $1.75 million. The tax rate is 35%. It finances 25%, 50% and 75% of its assets with debt at costs of 9%,10& and 12% respectively. Discuss your results. a. Determine the ROE under three models. b. Which capital structure is best and why? c. What if EBIT increases by 10%, which capital structure is best?
Your company faces a 34% tax rate and has $258 million in assets, currently financed entirely...
Your company faces a 34% tax rate and has $258 million in assets, currently financed entirely with equity. Equity is worth $8.80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Pessimistic Optimistic Probability of State .25 .75 Expect EBIT in...
Consider the following information about Earl Grey, Inc. Total assets $250 million Total debt $110 million...
Consider the following information about Earl Grey, Inc. Total assets $250 million Total debt $110 million Preferred stock $ 35 million Common stockholders' equity $105 million Net profits after taxes $25.5 million Number of preferred stock outstanding 1.5 million shares Number of common stock outstanding 9 million shares Preferred dividends paid $2.5 per share Common dividends paid $0.70 per share Market price of the preferred stock $32.55 per share Market price of the common stock $26.00 per share Use the...
Consider the following information about Earl Grey, Inc. Total assets $250 million Total debt $110 million...
Consider the following information about Earl Grey, Inc. Total assets $250 million Total debt $110 million Preferred stock $ 35 million Common stockholders’ equity $105 million Net profits after taxes $25.5 million Number of preferred stock outstanding 1.5 million shares Number of common stock outstanding 9 million shares Preferred dividends paid $2.5 per share Common dividends paid $0.70 per share Market price of the preferred stock $32.55 per share Market price of the common stock $26.00 per share Use the...
An analyst has collected the following information regarding Christopher Co.: · The company's capital structure is...
An analyst has collected the following information regarding Christopher Co.: · The company's capital structure is 70 percent equity, 30 percent debt. · The yield to maturity on the company's bonds is 8 percent. · The company's year-end dividend (D1) is forecasted to be $1.1 a share. · The company expects that its dividend will grow at a constant rate of 5 percent a year. · The company's stock price is $25. · The company's tax rate is 40 percent....
An analyst has collected the following information regarding Christopher Co.: • The company’s capital structure is...
An analyst has collected the following information regarding Christopher Co.: • The company’s capital structure is 70 percent equity, 30 percent debt. • The yield to maturity on the company’s bonds is 9 percent. • The company’s year-end dividend is forecasted to be $0.80 a share. • The company expects that its dividend will grow at a constant rate of 9 percent a year. • The company’s stock price is $25. • The company’s tax rate is 40 percent. •...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT