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Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The companys EBIT was $50 million last

Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The companys EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firms investment banker the following estimated costs of debt for the firm at different capital structures:

Percent Financed with Debt (wd) , rd

0% ,

20 , 8.0%

30 , 8.5

40 , 10.0

50 , 12.0

If the company were to recapitalize, then debt would be issued and the funds received would be used to repurchase stock. Pizza Palace is in the 40% state-plus-federal corporate tax bracket, its beta is 1.0, the risk-free rate is 6%, and the market risk premium is 6%.

a. Calculate the cost of capital given the information provide for each of the debt levels provided in the table at the beginning of the problem. Use the WACC formula for each debt (and implied equity) amount provided. You will need to use the WACC equation, the CAPM equation and also the Hamada equation. (Start with the Hamada, then use the output of that as your beta in the CAPM, and finally use that in the WACC equation.)

b. Using the free cash flow valuation model, show the only avenues by which capital structure can affect value.

Please show how to calculate each equation in Excel and show how it was done (explain step-by-step please). Please show/explain how to use the FCF valuation model in terms of capital structure. Thank you!

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