Pettit Printing Company has a total market value of $100 million, consisting of
ID: 2788128 • Letter: P
Question
Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $11.34 million, and its tax rate is 40%. Pettit can change its capital structure either by increasing its debt to 65% (based on market values) or decreasing it to 35%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 14% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 996 coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13% Present situation (50% debt) What is the firm's WACC? Round your answer to three decimal places What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. million 65% debt: What is the firm's WACC? Round your answer to two decimal places What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. million 35% debt: What is the firm's WACC? Round your answer to two decimal places What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. millionExplanation / Answer
Present situation
Weight of Equity = (1million share x $50 per share) / $100m = 0.50
Weight of debt = $50m / $100m = 0.50
Cost of debt (post tax) = 10% x (1 - 0.40) = 6%
WACC = Cost of equity x weight of equity + Cost of debt x weight of debt
WACC = 14% x 0.50 + 6% x 0.50 = 10%
To compute the total corporate value, we compute the NOPAT (Net operating profit after tax) first -
NOPAT = EBIT x (1 - T) = $11.34m x (1 - 0.40) = $6.804 million
Total corporate value = NOPAT / WACC = $6.804 million / 0.10 = $68.04 million
65% debt
In this option, the company will call all bonds worth $50m and issue new bonds @14% coupon rate.
Weight of equity = 35% (100% -65%) , Weight of debt = 65%, cost of equity = 16%,
cost of debt = 14% x (1 - 0.40) = 8.4%
WACC = 16% x 0.35 + 8.4% x 0.65 = 11.06%
The NOPAT will remain the same.
Total corporate value = $6.804m / 0.1106 = $61.52m
35% debt
In this option, the company will call all bonds worth $50m and issue new bonds @9% coupon rate.
Weight of equity = 65% (100% - 35%) , Weight of debt = 35%, cost of equity = 13%,
cost of debt = 9% x (1 - 0.40) = 5.4%
WACC = 13% x 0.65 + 5.4% x 0.35 = 10.34%
The NOPAT will remain the same.
Total corporate value = $6.804m / 0.1034 = $65.80m
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