Question

Piedmont Printing Company has a total market value of $120 million, consisting of 1 million shares selling for $60 per share and $60 million of 9% perpetual bonds now selling at par. The company’s EBIT is $15.888 million, and its tax rate is 25%. Piedmont can change its capital structure by either increasing its debt to 65% or decreasing it to 35%. If it decides to increase its use of leverage, it must call its old bonds and replace them with new ones with a 11% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 7% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. The firm pays out all earnings in dividends; hence, its stock is a zero-growth stock. Its current cost of equity is 13%. If it increases leverage, the cost of equity will be 15%. If it decreases leverage, the cost of equity will be 11%. What is the total corporate value if Piedmont decreases its leverage?

Answer 1