As Chief Financial Officer of the Magnificent Electronics Corporation (MEC), you are considering a recapitalization plan that

Question:

As Chief Financial Officer of the Magnificent Electronics Corporation (MEC), you are considering a recapitalization plan that would convert MEC from its current all-equity capital structure to one including substantial financial leverage. DIC now has 500,000 shares of common stock outstanding, which are selling for $60 each, and you expect the firm’s EBIT to be $2,400,000 per year for the foreseeable future. The recapitalization proposal is to issue $15,000,000 worth of long-term debt at an interest rate of 6.0 percent and use the proceeds to repurchase 250,000 shares of common stock worth $15,000,000. Assuming there are no market frictions such as corporate or personal income taxes, calculate the expected return on equity for MEC shareholders under both the current all-equity capital structure and under the recapitalization plan.

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a... Corporation
A Corporation is a legal form of business that is separate from its owner. In other words, a corporation is a business or organization formed by a group of people, and its right and liabilities separate from those of the individuals involved. It may... Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...