Boston Textiles has an all-common-equity capital structure. Pertinent financial characteristics for the company are shown below: Shares

Question:

Boston Textiles has an all-common-equity capital structure. Pertinent financial characteristics for the company are shown below:

Shares of common stock outstanding = 1,000,000

Common stock price, p0 = $20 per share

Expected level of EBIT = $5,000,000

Dividend payout ratio = 100 percent

In answering the following questions, assume that corporate income is not taxed. Under the present capital structure, what is the total value of the firm?

What is the cost of common equity capital, Kc?

Now suppose that Boston Textiles sells $1 million of long-term debt with an interest rate of 8 percent.

The proceeds are used to retire outstanding common stock. According to NOI theory (the independence hypothesis),

What will be the firm’s cost of common equity after the capital structure change?

What will be the dividend per share flowing to the firm’s common shareholders?

By what percent has the dividend per share changed owing to the capital structure change?

By what percent has the cost of common equity changed owing to the capital structure change?

What will be the composite cost of capital after the capital structure change?

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... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...