Capital Structure Analysis Pettit Printing Company has a total market value of $

Question

Capital Structure Analysis

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 $10.63 million, and its tax rate is 40%. 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 11% 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):
a) What is the firm's WACC? Round your answer to three decimal places.
     %
b) 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:
c) What is the firm's WACC? Round your answer to two decimal places.
      %
d) 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:
e) What is the firm's WACC? Round your answer to two decimal places.
      %
f) 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

a) WACC = wd x kd x (1 - tax) + we x ke

= 50% x 10% x (1 - 40%) + 50% x 14% = 10%

b) Corporate Value = EBIT x (1 - tax) / WACC = 10.63 x (1 - 40%) / 10% = $63.78 million

c) WACC = 70% x 11% x (1 - 40%) + 30% x 16% = 9.42%

d) Value = 10.63 x (1 - 40%) / 9.42% = $67.71 million

e) WACC = 30% x 7% x (1 - 40%) + 70% x 13% = 10.36%

f) Value = 10.63 x (1 - 40%) / 10.36% = $61.56 million

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