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Chap 5 Exercise

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26 views

Chap 5 Exercise

Uploaded by

k60.2113150049
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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EXERCISES

1. Money, Inc., has no debt outstanding and a total market value of $275,000. Earnings before interest
and taxes, EBIT, are projected to be $21,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will

EXERCISE
be 40 percent lower. Money is considering a $99,000 debt issue with an interest rate of 8 percent. The
proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding.
Ignore taxes for this problem.
a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is
issued. Also calculate the percentage changes in EPS when the economy expands or enters a recession.
b. Repeat part (a) assuming that Money goes through with recapitalization. What do you observe?

2. Repeat parts (a) and (b) in Problem 1 assuming Money has a tax rate of 35 percent.
3. Suppose the company in Problem 1 has a market-to-book ratio of 1.0.
a. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is
issued. Also calculate the percentage changes in ROE for eco- nomic expansion and recession,

b.
EXERCISE
assuming no taxes.
Repeat part (a) assuming the firm goes through with the proposed recapitalization.
c. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 35 percent.
4. Rolston Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a
levered plan (Plan II). Under Plan I, Rolston would have 265,000 shares of stock outstanding. Under
Plan II, there would be 185,000 shares of stock outstanding and $2.8 million in debt outstanding. The

a. EXERCISE
interest rate on the debt is 10 percent and there are no taxes.
If EBIT is $750,000, which plan will result in the higher EPS?
b. If EBIT is $1,500,000, which plan will result in the higher EPS? c. What is the break-even EBIT?

5. In Problem 4, use MM Proposition I to find the price per share of equity under each of the two
proposed plans. What is the value of the firm?

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