1. The Rivoli Company has no debt outstanding and its financial position is give
ID: 2723733 • Letter: 1
Question
1. The Rivoli Company has no debt outstanding and its financial position is given by the following data:
Market value of Assets $3,000,000
EBIT $ 500,000
Stock price $15
Shares outstanding 200,000
Tax rate 40%
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, the bonds can be sold at a cost, rd, of 7%. Rivoli is a no-growth firm and all of its earnings are paid out as dividends.
a. What is Rivoli’s current cost of equity?
b. If the risk free rate is 3 percent and the market risk premium is 5 percent, what is UP’s unlevered beta?
c. What is the levered beta at the new capital structure of 30 percent debt?
d. What is the new cost of equity under the capital structure financed with 30 percent debt?
e. What is its new weighted average cost of capital?
f. What is the new total corporate value of Rivoli?
g. What is the new stock price?
h. How many shares remain outstanding after the recapitalization?
Explanation / Answer
a)current cost of equit= EAT/market value of equity
=$ 300,000/3,000,000
=10%
b) Ke =Rf + u*risk premium
.10=.03+u*.05
u=1.4
L = u (1+ ((1-t)D/E))
=1.4(1+((1-.40).3/.7
=1.76
(d) Ke =.03+1.76*.05
=11.8%
(e) WACC =.3*.042+.7*.118
=9.52%
(f) 3,000,000/.0952
=5,252,100
(g) no of shares outstanding 200,000-900,000/15
140,000
new stock price 3,151,260-900,000/140,000
16.08
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