Question 1: The Jean Outlet is an all equity firm that has 135000 shares of stoc

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Question 1: The Jean Outlet is an all equity firm that has 135000 shares of stock outstanding. The company has decided to borrow the $2.5 million to repurchase 15800 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

Provide your answer in dollars, to the nearest $1. Do not enter the dollar sign, or any other punctuation.

Question 2: Billy's is currently an all equity firm that has 105000 shares of stock outstanding at a market price of $37.13 a share. The firm has decided to leverage its operations by issuing $130000 of debt at an interest rate of 4.2 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that must be achieved in order for this to occur (that is, what is the breakeven EBIT?) Ignore taxes.

Question 3: Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Galaxy would have 245000 shares of stock outstanding. Under Plan II, there would be 237014 shares of stock outstanding and $310000 in debt outstanding. The interest rate on the debt is 9.9 percent and there are no taxes. What is the breakeven EBIT?

Question 4: Sewer's Paradise is an all equity firm that has 41000 shares of stock outstanding at a market price of $36.52 a share. The firm's management has decided to issue $50000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 5.0 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes. Provide your answer to the nearest $0.01.

Question 5: Georga's Restaurants has 8500 bonds outstanding with a face value of $1,000 each and a coupon rate of 6.6 percent. The interest is paid semi-annually. What is the present value of the interest tax shield if the tax rate is 34 percent? (That is, how much does the tax shield add to the value of the firm?)

Explanation / Answer

1) As $ 2.5 M is used to repurchase 15800 shares, Price/ Share = 2.5M/15,800 = 158.22

Number of outstanding shares after repurchase = 135,000-15,800 = 119,200

Total Market Value of shares = 158.22* 119200 = 18.85 M

Value of debt = 2.5 M

Total Value of firm = Market Value of Shares + Value of Debt = 18.85 + 2.5 = 21.35 M

2) To find the break even EBIT , we can set the equations for EPS equal to each other if they are using different capital structures.

Number of O/S shares = 105000

Number of shares repurchased with $ 130,000 = 130,000/37.13 =3690

Number of O/S shares after repurchase= 105,000- 3690 =101,310 shares

iie EBIT/105,000 = [EBIT - 0.042* 130,000]/101,310

EBIT/105,000= [EBIT - 5460]/101,310

EBIT = 1.03 EBIT- 5658.86

0.03 *EBIT = 5658.86

Break Even EBIT = 188,628.96

3)

EBIT/245,000 = [EBIT- 9.9%* 310,000]/237,014

0.96 EBIT = EBIT- 30690

0.04 EBIT = 30,690

Break Even EBIT = $767,250

4)

Shares repurchased = 50000/36.52 = 1369

Number of O/S shares = 41000-1369 =39631 shares

EBIT/41,000 = [EBIT - 0.05* 50,000]/39631

0.96 EBIT = EBIT - 2500

0.04 EBIT = 2500

Break even EBIT = 62,500

Earnings per share = 62,500/39631 = 1.577

5)

Interest tax shield = Interest payment * Tax rate

Interest payment = 1000*8500 * 6.6% = $561,000 per year

Value of tax shield per year = 561000* 34% = $ 190,740

Note :To find Present value, we need discount rate, number of years of bond repayment etc. These details are not provided in the question

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