ST-1) Optimal Capital Structure

The Rogers Company is currently in this situation: (1) EBIT = $4.7 million; (2) tax rate, T = 25%; (3) value of debt, D = $2 million; (4) r_d = 10%; (5) r_s = 15%; (6) shares of stock outstanding, n = 600,000; and (7) stock price, P = $30. The firms market is stable and it expects no growth, so all earnings are paid out as dividends. The debt consists of perpetual bonds.

a. What is the total market value of the firms stock, S, and the firms total market value, V?

b. What is the firms weighted average cost of capital?

c. Suppose the firm can increase its debt by issuing debt and repurchasing stock so that its capital structure will have 50% debt, based on market values. At this level of debt, its cost of equity rises to 18.5% and its interest rate on all debt will rise to 12%. (It will have to call and refund the old debt.) What is the WACC under this capital structure? What is the total value? How much debt will it issue, and what is the stock price after the repurchase? How many shares will remain outstanding after the repurchase?