CH16 Optimum Capital Structure Boring Basies (BBS) is a profitable company that has stayed the same size for the past few years (as measured by its Balance Sheets, Income Statements and Cash Flow Statements). Your team expects BBS to maintain this steady-state condition into perpetuity, except for possible changes to its capital structure. This simple firm has no accruals, no PPE or etc, so for any given year its NI = FCF to owners. The firm is currently debt free. Notes Here is a bunch of data for the company: Annual Income Statement SMM VON Revenue $185.00 - SGA ($155.00) -Interest $0.00 =EBT $30.00 - Tax ($10.50) =NI $19.50 = FCF $19.50 Company is currently debt free. FCFNI because of no accruals, PPE, etc. Rates and other constants 1.00% M 7.00% Bu Tax rate 1.20 35.00% Variable Ratlos and Rates Case 1 2 3 4 5 D/(D+E) = WD 0.0% 20.00% 50.0% 80.0% 90.0% To (pretax) 8.50% 9.40% 11.00% 13.00% 17.00% 29.00% WACC 0.0940 0.0978 0.0964 0.1109 assume the given waces are correct, even if your computations disagree. BBS is for sale for the price shown below (for 100% of the firm's stock). A Debt/Equity team (not the same as your's above) would like to buy the firm and refinance the debt. As part of the transaction, the team will establish BBS's D/(D+E) at the team's view of BBS' optimal capital structure, as shown below. IE: The overall team will use some of the Equity team member's cash to fund the transaction, and have the firm take out a loan from the Debt Team members on the purchase date to fund any remaining amount. Purchase price of firm (100% of the firm's stock): D/(D+E) ratio that the team sets for BBS: $160.00 MM 75.00% ja 5 15 Part 2 (Not your team): What is the size of the loan that the Debt team members will make to the firm on the date of purchase? U 06 1 Part 2 (Not your team): What is the amount that the Equity team members will contribute to the transaction to purchase and recapitalize the firm? D 947 15 Part 1 (Your team): What is your team's estimate of the firm's WACC for Case 3? 8 1 Part 3 (Applicable to any team): Why does optimum WACC correspond to an entity's optimum leverage for all stakeholders? Minimum (optimal) WACC maximizes the present value of each posative future cash flow, Maximum (optimal) WACC corresponds to an entity's optimum ROE. O Maximum (optimal) WACC minimizes the project's negative cash flows. Minimum (optimal WACC makes the present value of some negative cash flows into positive numbers Minimum (optimal) WACC corresponds to an optimal liquidity ratio. 09 13 Part 1 (Your team): Which case corresponds to the optimal WACC? Case 3 Case 5 Case 1 Case 4 Case 2 CH16 Optimum Capital Structure Boring Basies (BBS) is a profitable company that has stayed the same size for the past few years (as measured by its Balance Sheets, Income Statements and Cash Flow Statements). Your team expects BBS to maintain this steady-state condition into perpetuity, except for possible changes to its capital structure. This simple firm has no accruals, no PPE or etc, so for any given year its NI = FCF to owners. The firm is currently debt free. Notes Here is a bunch of data for the company: Annual Income Statement SMM VON Revenue $185.00 - SGA ($155.00) -Interest $0.00 =EBT $30.00 - Tax ($10.50) =NI $19.50 = FCF $19.50 Company is currently debt free. FCFNI because of no accruals, PPE, etc. Rates and other constants 1.00% M 7.00% Bu Tax rate 1.20 35.00% Variable Ratlos and Rates Case 1 2 3 4 5 D/(D+E) = WD 0.0% 20.00% 50.0% 80.0% 90.0% To (pretax) 8.50% 9.40% 11.00% 13.00% 17.00% 29.00% WACC 0.0940 0.0978 0.0964 0.1109 assume the given waces are correct, even if your computations disagree. BBS is for sale for the price shown below (for 100% of the firm's stock). A Debt/Equity team (not the same as your's above) would like to buy the firm and refinance the debt. As part of the transaction, the team will establish BBS's D/(D+E) at the team's view of BBS' optimal capital structure, as shown below. IE: The overall team will use some of the Equity team member's cash to fund the transaction, and have the firm take out a loan from the Debt Team members on the purchase date to fund any remaining amount. Purchase price of firm (100% of the firm's stock): D/(D+E) ratio that the team sets for BBS: $160.00 MM 75.00% ja 5 15 Part 2 (Not your team): What is the size of the loan that the Debt team members will make to the firm on the date of purchase? U 06 1 Part 2 (Not your team): What is the amount that the Equity team members will contribute to the transaction to purchase and recapitalize the firm? D 947 15 Part 1 (Your team): What is your team's estimate of the firm's WACC for Case 3? 8 1 Part 3 (Applicable to any team): Why does optimum WACC correspond to an entity's optimum leverage for all stakeholders? Minimum (optimal) WACC maximizes the present value of each posative future cash flow, Maximum (optimal) WACC corresponds to an entity's optimum ROE. O Maximum (optimal) WACC minimizes the project's negative cash flows. Minimum (optimal WACC makes the present value of some negative cash flows into positive numbers Minimum (optimal) WACC corresponds to an optimal liquidity ratio. 09 13 Part 1 (Your team): Which case corresponds to the optimal WACC? Case 3 Case 5 Case 1 Case 4 Case 2
