Question
Capital Structure Analysis The Rivoli Company has no debt outstanding, and its financial position is given by the following data: Assets (Market value = book
Capital Structure Analysis
The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
Assets (Market value = book value) $3,000,000
EBIT $500,000
Cost of equity, rs 10%
Stock price, Po $15
Shares outstanding, no 200,000
Tax rate, T (federal-plus-state) 40%
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 6%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.
What effect would this use of leverage have on the value of the firm? I. Increasing the financial leverage by adding debt results in a decrease in the firm's value. II. Increasing the financial leverage by adding debt has no effect on the firm's value. III. Increasing the financial leverage by adding debt results in an increase in the firm's value.
B. What would be the price of Rivoli's stock? Do not round intermediate calculations. Round your answer to the nearest cent. $ per share
What happens to the firm's earnings per share after the recapitalization? (Increase or Decrease its EPS by ______) Do not round intermediate calculations. Round your answer to the nearest cent. The firm (Increased or Decreased) its EPS by $ .
The $500,000 EBIT given previously is actually the expected value from the following probability distribution:
Probability | EBIT |
0.10 | - $ 85,000 |
0.20 | 150,000 |
0.40 | 550,000 |
0.20 | 750,000 |
0.10 | 1,085,000 |
Determine the times-interest-earned ratio for each probability. Do not round intermediate calculations. Round your answers to two decimal places.
Probability | TIE |
0.10 | |
0.20 | |
0.40 | |
0.20 | |
0.10 |
What is the probability of not covering the interest payment at the 30 percent debt level? Do not round intermediate calculations. Round your answer to two decimal places. ___ %
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started