Question
Choose a company from Yahoo Finance that has a positive free cash flow (FCF) in one or more of the recent years (You do not
Choose a company from Yahoo Finance that has a positive free cash flow (FCF) in one or more of the recent years (You do not have to calculate the FCF by yourself, you can take a recent value reported by Yahoo Finance). Then suppose that the following assumptions hold: Currently, the company has no debt, no short term investments and no preferred stock. The beta of the company is 1.5, the risk-free rate is 5%, market risk premium is 6% and the tax rate is 20%. Number of shares outstanding is 2 million. The company is considering a change in its capital structure so as to maximize its value and share price. So, as the financial manager of this company, you consult with reputable investment bankers to have an estimate of interest rates that lenders would demand from your company for different levels of debt ratios. Investment bankers provide the following rates:
Debt Ratio: 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Cost of Debt 0% 6% 7% 8% 9% 10% 12% 14% 16% 20%
a. Using the information that you obtained and also given, find the optimal capital structure for this company that maximizes its value. Please also provide the maximum total value of the company as well as the corresponding values of debt and equity.
b. According to your calculations, what should the firm do?
c. Suppose the firm chooses to recapitalize to reach to the optimal capital structure by issuing enough additional debt and using the debt proceeds to repurchase some of its stock. Prepare a table that shows the total value, value of debt, value of equity, number of shares outstanding and share price for each of the following states:
i. Before debt,
ii. After debt but before the repurchase,
iii. After the repurchase
Please take constant FCF growth rate of zero
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