Question
You have just been hired as the Chief Financial Officer (CFO) of the Ski Shop, a chain of ski equipment stores. The CEO has asked
You have just been hired as the Chief Financial Officer (CFO) of the Ski Shop, a chain of ski equipment stores. The CEO has asked that your first project be an evaluation of the firms capital structure. The Ski Shop has expanded aggressively in recent years and its debt ratio has increased substantially. In fact, it now exceeds the ratios of other firms in the industry. You have determined that a change in capital structure that involves issuing $300 million of new equity and using it to retire long-term debt would put the companys leverage in line with that of others in the industry. You have been asked to prepare an analysis of the issue and make a recommendation.
Provide answers to the following questions: a) What are the companys current equity value, firm value, and the debt-to-equity ratio? b) Assume that after recapitalization, the equity value increases by $50 million, in addition to the $300 million new equity issue. What would be the equity value, firm value, and the debt-to-equity ratio after the recapitalization is completed?
You then estimate that the lower debt ratio would result in the firms debt rating to improve from B to AAA. c) What is the firms current (before recapitalization) WACC? d) What would the firms WACC be following the recapitalization? Does it make sense to do the recapitalization?
The Ski Shop Balance sheet, in millions Liabilities and equity Assets Short-Tem Debt Cash 30 Accounts Payable Accounts Receivable 60 400 Inventory Current Liabilities Current Assets 490 Long-Tem Debt Common Stock (at $1 par Gross PPE cumulated Depreciation 160 Additional Paid-in Capital 410 Net PPE Retained Eamings 900 Total Total other data: Stock price per share $24. Number of shares outstanding-20,000,000 Current levered equity beta 1.6 Interest rate on B-rated debt -10 Interest rate on BBB-rated debt 9% Interest rate on A-rated debt 8% Interest rate on AAA-rated debt-7% Interest rate on Treasury Bills 34% Expected Return on the Market Portfolio 12% Corporate Tax Rate 30% 150 30 180 570 20 50 80 900 The Ski Shop Balance sheet, in millions Liabilities and equity Assets Short-Tem Debt Cash 30 Accounts Payable Accounts Receivable 60 400 Inventory Current Liabilities Current Assets 490 Long-Tem Debt Common Stock (at $1 par Gross PPE cumulated Depreciation 160 Additional Paid-in Capital 410 Net PPE Retained Eamings 900 Total Total other data: Stock price per share $24. Number of shares outstanding-20,000,000 Current levered equity beta 1.6 Interest rate on B-rated debt -10 Interest rate on BBB-rated debt 9% Interest rate on A-rated debt 8% Interest rate on AAA-rated debt-7% Interest rate on Treasury Bills 34% Expected Return on the Market Portfolio 12% Corporate Tax Rate 30% 150 30 180 570 20 50 80 900Step by Step Solution
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