The Rivoli Company has no debt outstanding and its financial position is given b

Question

The Rivoli Company has no debt outstanding and its financial position is given by the following data: the firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity will increase to 11% to reflect the increased risk. Bonds can be sold at a cost, of 7% Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time. What effect would this use of leverage have on the value of the firm? What would be the price of Rivoli's stock? What happens to the firm's earnings per share after the recapitalization? C The $500, 000 EBIT given previously is actually the expected value from the following probability distribution:

Explanation / Answer

Capital structure of Rivoli company

Calculation of earning per share

Earning per share

( net income ÷no of equity shares)

1.5

After recapitalization earnings per share is increased to 1.87 from 1.5

Before recapitalization after recapitalization Total capital 3000000 3000000 Equity capital 3000000 2100000 ( 70%) Debt capital 0 900000 ( 30% ) No. Of equity shares 200000 140000

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