The A. J. Croft Company (AJC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6 percent. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero-growth company. AJC's current cost of equity is 8.775 percent, and its tax rate is 35 percent. The firm has 12,000 shares of common stock outstanding selling at a price per share of $50.00.

1. What is AJC's current total market value and weighted average cost of capital? (Hint: V = market value of debt + market value of equity)

2. The firm is considering moving to a capital structure that is comprised of 45 percent debt and 55 percent equity, based on market values. The new funds would be used to replace the old debt and to repurchase stock. It is estimated that the increase in riskiness resulting from the leverage increase would cause the required rate of return on debt to rise to 7.5 percent, while the required rate of return on equity would increase to 9.2 percent. If this plan were carried out, what would be AJC's new WACC and total value? (Hints: once you calculate the new WACC, you can discount the FCF to find the total value. Again, zero growth means FCF = NOPAT.)

3. Now assume that AJC is considering changing from its original capital structure to a new capital structure with 35 percent debt and 65 percent equity. If it makes this change, its resulting total market value would be $820,000. What would be its new stock price per share? (Hint: use the lecture slides to do a before/after debt issue comparison to calculate stock price per share...since Vop increases, so must stock price!)

4. Now assume that AJC is considering changing from its original capital structure to a new capital structure that results in a stock price of $52.50 per share. The resulting capital structure would have a $326,550 total market value of equity and $503,450 market value of debt. How many shares would AJC repurchase in the recapitalization? (Hint: use the lecture slides to do the next step: share price after repurchase.)

5. Looking at the results of problems 11-14, what can you deduce about the optimal capital structure for this firm?