Question 4 and 5 please with workings iii) What is the firm\'s WACC after restru

Question

Question 4 and 5 please with workings

iii) What is the firm's WACC after restructuring? iv) How many shares remain after recapitalization? v) What is the firm's corporate value after restructuring? 4. Two othenvise identical companies differ only with respect to their capital structure. Gizmo Inc is unlevered while Acme Inc. has S15 million of 7% bonds outstanding. The corporate tax rate is 34%. EBIT is $3 million and the ris 10%. Assume all MM assumptions are satisfied. i. What is the value of each firm? ii. What is r, for Acme? What is St for Acme? What is the WACC for Acme? iii. iv. 5. The capital budget of the Aloopalak Co. has three projects of different risks. The risk adjusted cost of capital for the three projects X, Y and Z is 18%, 12% and 8%. Their respective IRRs are 22%, 1 100 and 10%. Each project is $3.25 million. The capital structure of the company is 40% debt and 60% equity and its net income is expected to be $5 million. If Aloopalak maintains its residual dividend policy what will be its payout ratio?

Explanation / Answer

5.

Net Income = $5 million.

IRR of project X and Z is higher than its cost of capital while IRR of project Y is less than its cost of capital. So company should accept project X and Z and reject project Y.

So total capital required for both project = $3.25 + $3.25

= $7.50 million.

Ttal capital required for project X and Z is $7.50 million.

Proportion of equity required = 60%.

So, value of equity required = $7.50 × 60%

= $4.50 million.

for both project total equity required is $4.50 million and debt required is $3 million.

Residual dividend policy is type of dividend policy in which first company use its earnings for the capital investment in current. The amount remained after fulfilling all the obligation of capital investment, pays to shareholder as dividend.

So total amount remains for dividend = $5 million - $4.50 million

= $0.50 million.

Total dividend paid is $0.50 million.

Payout ratio = $0.50 / $5

= 10%

Payout ratio is 10%.

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