Question

Pettit Printing Company has a total market value of $ 100 million, consisting of 1 million shares selling for $ 50 million of 10% perpetual bonds now selling at par. The company's EBIT is $ 13. 24 million, and its tax rate is 15%. Pettit can change its capital structure by either increasing its debt to 70% ( based on market values ) or decreasing it to 30%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 8% 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 as dividends; hence, its stock is a zero-growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13% . What is the firm's WACC and total corporate value under each capital structure?

Answer 1