Pettit Printing Company has a total market value of $100 million, consisting of

Question

Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $13.60 million, and its tax rate is 15%. Pettit can change its capital structure either by 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 13% coupon. If it decides to decrease its leverage, it will call in 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 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%.

Present situation (50% debt):
What is the firm's WACC? Round your answer to three decimal places.
     %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$   million

70% debt:
What is the firm's WACC? Round your answer to two decimal places.
      %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$   million

30% debt:
What is the firm's WACC? Round your answer to two decimal places.
      %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$   million

Explanation / Answer

Present Situation

WACC = wd x kd x (1 - tax) + we x ke = 50% x 10% x (1 - 15%) + 50% x 14% = 11.25%

Total Value = EBIT x (1 - tax) / WACC = 13.60 x (1 - 15%) / 11.25% = $102.756

70% Debt

WACC = wd x kd x (1 - tax) + we x ke = 70% x 13% x (1 - 15%) + 30% x 16% = 12.54%

Total Value = EBIT x (1 - tax) / WACC = 13.60 x (1 - 15%) / 12.54% = $92.222

30% Debt

WACC = wd x kd x (1 - tax) + we x ke = 30% x 7% x (1 - 15%) + 30% x 13% = 10.88%

Total Value = EBIT x (1 - tax) / WACC = 13.60 x (1 - 15%) / 10.88% = $106.201

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