Question
Lakamuun Inc. is a firm which is into the production of wool. The firm has an expected EBIT of $500,000 and this will remain constant
Lakamuun Inc. is a firm which is into the production of wool. The firm has an expected EBIT
of $500,000 and this will remain constant overtime. Lakamuun pays out all its earnings as
dividends. Lakamuun currently finances all its operations with equity. Lakamuun has 100,000
shares outstanding. If the share price is $20, a risk free rate of 600 basis points, a market risk
premium of 400bp and a marginal tax rate of 40%.and the book value of equity I s equal to
the market value.
Lakamuun decides to recapitalise by issuing debt to repurchase stock. The amount of debt
borrowed and their respective costs of debt are shown in the table below.
| Amount borrowed $ | Cost of debt (kd) |
| 0 | - |
| 350,000 | 12% |
| 600,000 | 14% |
| 800,000 | 15% |
| 1,800,000 | 16% |
Required
a. Calculate the following at each level of debt
i. Cost of equity
ii. Value of equity
iii. Total value of the firm
b. Deduce the following
i. The price per share
ii. The earnings per share
iii. The WACC
c. Deduce the optimal capital structure of the firm and justify your answer.
Lakamuun Inc. is a firm which is into the production of wool. The firm has an expected EBIT
of $500,000 and this will remain constant overtime. Lakamuun pays out all its earnings as
dividends. Lakamuun currently finances all its operations with equity. Lakamuun has 100,000
shares outstanding. If the share price is $20, a risk free rate of 600 basis points, a market risk
premium of 400bp and a marginal tax rate of 40%.and the book value of equity I s equal to
the market value.
Lakamuun decides to recapitalise by issuing debt to repurchase stock. The amount of debt
borrowed and their respective costs of debt are shown in the table below.
| Amount borrowed $ | Cost of debt (kd) |
| 0 | - |
| 350,000 | 12% |
| 600,000 | 14% |
| 800,000 | 15% |
| 1,800,000 | 16% |
Required
a. Calculate the following at each level of debt
i. Cost of equity
ii. Value of equity
iii. Total value of the firm
b. Deduce the following
i. The price per share
ii. The earnings per share
iii. The WACC
c. Deduce the optimal capital structure of the firm and justify your answer.
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The Financial Services Marketing Handbook
Authors: Evelyn Ehrlich
2nd Edition
1118065719, 978-1118065716
