A consultant has collected the following information regarding Young Publishing:

Question

A consultant has collected the following information regarding Young Publishing:

The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm?

A consultant has collected the following information regarding Young Publishing:

Total Assets $3,000 million Tax Rate 40% Operating Income (EBIT) $800 million Debt Ratio 0% Interest Expense $0 million WACC 10% Net Income $480 million M/B Ratio 1.00x Share Price $32.00 EPS=DPS $3.20

The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm?

Explanation / Answer

Total Number of Shares at Present= Net Income / EPS

= 480,000,000 / 3.20 = 150,000,000

Present Market Value of the Firm = 150,000,000 x 32 = $4,800,000,000 or 4,800 millions

If 20% Debt is Used than New Capital Structure will be:

Debt = $960,000,000 Equity = $3,840,000,000

So, the Total Market Value of the Firm will Be $3,840,000,000

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