Problem 15-9 Capital Structure Analysis

Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $12.44 million, and its tax rate is 35%. Pettit can change its capital structure either by increasing its debt to 60% (based on market values) or decreasing it to 40%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 11% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 7% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change.

The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%.

Present situation (50% debt): What is the firm's WACC? Round your answer to three decimal places. % What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million

60% debt: What is the firm's WACC? Round your answer to two decimal places. % What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million

40% debt: What is the firm's WACC? Round your answer to two decimal places. % What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million

Problem 15-10 Optimal Capital Structure with Hamada

Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 6%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. The firm's EBIT is $15.847 million, and it faces a 35% federal-plus-state tax rate. The market risk premium is 5%, and the risk-free rate is 4%. BEA is considering increasing its debt level to a capital structure with 30% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 8%. BEA has a beta of 1.2.

What is BEA's unlevered beta before restructuring? Use market value D/S (which is the same as wd/ws) when unlevering. Round your answer to two decimal places.

What are BEA's new beta after releveraging and cost of equity if it has 30% debt? Round your answers to two decimal places.

Beta
Cost of equity	%

What is BEA's WACC after releveraging? Round your answer to two decimal places. % What is the total value of the firm with 30 % debt? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million

Problem 15-11 WACC and Optimal Capital Structure

F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows:

Market Debt- to-Value Ratio (wd)	Market Equity-to-Value Ratio (ws)	Market Debt- to-Equity Ratio (D/S)	Before-Tax Cost of Debt (rd)
0.0	1.0	0.00	7.0%
0.2	0.8	0.25	8.0
0.4	0.6	0.67	10.0
0.6	0.4	1.50	12.0
0.8	0.2	4.00	15.0

F. Pierce uses the CAPM to estimate its cost of common equity, rs. The company estimates that the risk-free rate is 4%, the market risk premium is 6%, and the company's tax rate is 30%. F. Pierce estimates that its beta now (which is "unlevered" since it currently has no debt) is 1.3. Based on this information, what is the firm's optimal capital structure, and what would the weighted average cost of capital be at the optimal capital structure? Do not round intermediate calculations. Round your answers to two decimal places.

DEBT	%
EQUITY	%
WACC	%