6.1 . São Paulo Inc. needs $40 million in new capital, which it may acquire by s

Question

6.1. São Paulo Inc. needs $40 million in new capital, which it may acquire by selling bonds at par with coupon 10% or by selling stock at $37 (net) per share. The current capital structure of São Paulo consists of $250 million (face value) of 8% coupon bonds selling at 95, and 11 million shares of stock selling at $40 apiece. After the new financing, the EBIT of São Paulo is expected to be $55 million with a standard deviation of $25 million. Which method of financing do you recommend? What is the probability that you are right? Answer: Stock, 65.10%. Show solutions.

Explanation / Answer

Answer: calculation of cash out flow under both proposal

1.) If choose issue of bonds

EBIT 55

Less interest expenses

exisisting interest 250*8%= 20

New interest 40*10% = 4 24

EBT 31

2.) if choose issue of stock

EBIT 55

Existing interest 20

EBT 35

We have EBT is more in issue of stock. So we choose the option of issue of stock.

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