The Rivoli Company has no debt outstanding, and its financial position is given

Question

The Rivoli Company has no debt outstanding, and its financial position is given by the following data: Assets (Market value = book value) $3,000,000 EBIT $500,000 Cost of equity, rs 10% Stock price, Po $15 Shares outstanding, no 200,000 Tax rate, T (federal-plus-state) 40% The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 40% debt based on market values, its cost of equity, rs, will increase to 11% to reflect the increased risk. Bonds can be sold at a cost, rd, of 8%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.

a.What would be the price of Rivoli's stock? Round your answer to the nearest cent.

b. What happens to the firm's earnings per share after the recapitalization? Round your answer to the nearest cent. The Firm increased its EPS by how much?? Round to nearest cent.

Explanation / Answer

Asset 3000000 no of shares Equity 60% 1800000 120000 Debt 40% 1200000 No of shares outstanding = 200000 New no of shares outstanding = 200000*60% = 120000 Earning before recapitalisation Earning after recapitalisation EBIT 500000 500000 Less Interest 0 96000 EBT 500000 404000 Less Tax 200000 161600 EAT 300000 242400 no of shares 200000 120000 EPS/DPS 1.5 2.02 Increase in EPS = (2.02-1.50)/1.50*100= 34.67% P0 = D1/k P0 = current price D1 = Dividend to equity stakeholders k = cost of equity P0= 2.02/.11 18.36

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.