XYZ Inc. is considering changing the company’s capital structure. The book-value
ID: 2806562 • Letter: X
Question
XYZ Inc. is considering changing the company’s capital structure. The book-value balance sheet includes the following assets and liabilities:
Current Assets: $1,000 & Debt: $2,500;
Net Fixed Assets: $4,000 & Equity: $2,500;
Total Assets: $5,000 & Total Liabilities: $5000 …… *Numbers are in millions of dollars*
Other Financial Information about XYZ Inc.:
XYZ Inc., debt is long-term bonds with a 10% coupon rate. The bonds are rated AA with a 12% Yield-to-Maturity of 12%, and the market value of the bond is 80% of par. The company’s T-Bond rating is 8%
XYZ Inc. has 50 million shares outstanding, $80 is the current market value price per share. XYZ Inc. pays $4 per share in dividend, and has a price to earnings (P/E) ratio of 10. The company’s stock has a beta of 1.2
XYZ Inc., will issue $3billion in new debt to repurchase its stock, which will change XYZ Inc. debt rating to CCC with a debt yield of 18%.
Questions: (show all calculations)
1. Calculate XYZ Inc. cost of equity after the company issues $3 billion in new debt to repurchase stock.
2. Determine XYZ Inc., Weighted Average Cost of Capital (WACC)
3. Calculate the company’s new share price, if there is no cost of financial distress imposed on the firm.
4. What impact does financial distress have on XYZ’s, impact on current bondholders, and the impact on stock price?
Explanation / Answer
As per the information provided, below is the position - In the Books of XYZ Inc. Current Position Revised Position Assets Amount in Million $ Amount in Million $ Description Net Fixed Assets 4000 4000 Current assets 1000 1000 Total Fixed assets 5000 5000 Liabilities & Equities Equity 2500 2200 Debt 2500 2800 Long Term Bond with 10% Coupon Rate Total Liabilites 5000 5000 1 - XYZ Cost of Equity Next Year's dividends per share / Current market value of stock + Growth rate of dividends (4/80)+1.2 6.20% 2. Weighted Average Cost of Capital (WACC) The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is firm's cost of capital. 9.87%
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