1. A firm with EBIT of $6.0 million and existing debt of $12.0 million would like to increase its debt further by another $8.0 million. However existing bond covenants restrict the EBIT/interest expense covenant to 3 times or more? Question 1: Can the new debt be raised? Its coupon would be 12%; the old debt carries a cost of 4%. The tax rate of the company is 18%. Question 2: What is the maximum debt that can be raised and still respect debt covenants?
2. A firm that believes in MM with taxes and is thinking about changing its capital structure to include debt. Presently it is only using equity but expects to raise $22 million in new debt. Questions: 1) what is the company's existing pre debt cost of equity? 2) What is the new value of the firm it is issues debt? And the value of the tax shield? 3) What is the new debt/equity ratio? 4) What is the cost of equity of the company with leverage? 5) Can you tell the treasurer what the new cost of capital for the firm would be if it intends to raise $18 million of debt. Today the company has a 25% tax rate and the value of the firm unlevered is $62 million. The new debt would have a coupon of 9% and the firm's EBIT is $22 million.
3. A firm with existing sales of $75,000,000 and a pretax margin of 6% is thinking about expanding into a new market. This will require an investment of $1,800,000. The company's tax rate is 35% and the company's existing P/E ratio is 14 and debt is $15,000,000. Question: Using the residual method, can the company pay a dividend of $0.30 per share? At this time the company has 2.0 million shares outstanding. What is the maximum amount of CAPEX the company can do?