6 . Myoptic Optical is a levered no-growth firm with $1,400,000 debt outstanding

Question

6 . Myoptic Optical is a levered no-growth firm with $1,400,000 debt outstanding . Firm value is $2,277,500 . The firm’s owner is currently contemplating whether to reduce its debt ratio to a more reasonable 40% . The unlevered cost of equity is 16% and the cost of debt is 6% . The firm curently has 35,100 shares outstanding and the firm’s tax rate is 35%

(a)What are Myoptic Optical’s current stock price and cost of levered (with debt) equity?

(b)what is Myopyic Optical’s EBIT?

(c)What will be the new value of the firm after the recapitalization to a 40% debt ratio(DebtValue)is announced?

(d)What is the firm’s stock price after it announces the change in capital structure?

(e)How many shares of stock must Myoptic Optical issue?

(f)What will be Myoptic Optical’s new cost of levered ( whit debt ) equity after the recapitalization?

(g)What will Myoptic Optical’s new WACC be ?

Explanation / Answer

P0 = (2,277,500 – 1,400,000)/35,100=25.

By MMII with taxes, rs =16%+(16% - 6%)(1 - .35)1,400,000/877,500=26.37%.

Vu =VL – tcB =2,277,500 – (.35)*1,400,000= 1,787,500 Then, Vu =1,787,500=EBIT (1 - .35)/(.16). Solving for EBIT yields EBIT=440,000.

The value of debt is B=0.4VL . By MMI with taxes, VL =VU +0.35B. Plugging in VU =1,787,500 and B=0.4VL , we have VL =1,787,500 + 0.35(0.4)VL . Solving for VL gives VL =2,078,488.

After announcement stock prices tend to increase or decrease.

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