1. Recapitalization
Tapley Inc. currently has total capital equal to $7 million, has zero debt, is in the 40% federalplusstate tax bracket, has a net income of $1 million, and pays out 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 4% per year, 290,000 shares of stock are outstanding, and the current WACC is 13.60%.
The company is considering a recapitalization where it will issue $3 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, its beforetax cost of debt will be 11% and its cost of equity will rise to 15.5%.
a. What is the stock's current price per share (before the recapitalization)? Round your answer to the nearest cent.
$ ________
b. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchased at the price calculated in Part a. Round your answer to the nearest cent. Do not round intermediate steps.
$ ________
2. Breakeven and leverage
Wingler Communications Corporation (WCC) produces premium stereo headphones that sell for $28.60 per set, and this year's sales are expected to be 450,000 units. Variable production costs for the expected sales under present production methods are estimated at $10,200,000, and fixed production (operating) costs at present are $1,560,000. WCC has $4,800,000 of debt outstanding at an interest rate of 9%. There are 240,000 shares of common stock outstanding, and there is no preferred stock. The dividend payout ratio is 70%, and WCC is in the 40% federalplusstate tax bracket.
The company is considering investing $7,200,000 in new equipment. Sales would not increase, but variable costs per unit would decline by 20%. Also, fixed operating costs would increase from $1,560,000 to $1,800,000. WCC could raise the required capital by borrowing $7,200,000 at 10% or by selling 240,000 additional shares of common stock at $30 per share.
a. What would be WCC's EPS (1) under the old production process, (2) under the new process if it uses debt, and (3) under the new process if it uses common stock? Round your answers to the nearest cent.
1. $ ________
2. $ ________
3. $ ________
b. At what unit sales level would WCC have the same EPS, assuming it undertakes the investment and finances it with debt or with stock? {Hint: V = variable cost per unit = $8,160,000/450,000, and EPS = [(PQ  VQ  F  I)(1  T)]/N. Set EPS_{Stock} = EPS_{Debt} and solve for Q.} Round your answer to the nearest whole.
________ units
4. Unlevered beta
Harley Motors has $17 million in assets, which were financed with $6.8 million of debt and $10.2 million in equity. Harley's beta is currently 0.95 and its tax rate is 40%. Use the Hamada equation to find Harley's unlevered beta, b_{U}. Round your answer to two decimal places.
________
5. Financing alternatives
The Severn Company plans to raise a net amount of $270 million to finance new equipment in early 2012. Two alternatives are being considered: Common stock may be sold to net $60 per share, or bonds yielding 12% may be issued. The balance sheet and income statement of the Severn Company prior to financing are as follows:
The Severn Company: Balance Sheet as of December 31, 2012 

Current assets 
$ 900.00 
Notes payable 
$ 255.00 

Net fixed assets 
450.00 
Longterm debt (10%) 
695.00 

Common stock, $3 par 
60.00 

Retained earnings 
340.00 

Total assets 
$1,350.00 
Total liabilities and equity 
$1,350.00 
The Severn Company: Income Statement for Year Ended December 31, 2012 (Millions of Dollars)
Sales 
$2,475.00 
Operating costs 
2,227.50 
Earnings before interest and taxes (10%) 
$247.50 
Interest on shortterm debt 
15.00 
Interest on longterm debt 
69.50 
Earnings before taxes 
$163.00 
Federalplusstate taxes (40%) 
65.20 
Net income 
$97.80 
The probability distribution for annual sales is as follows:
Probability 
Annual Sales 

0.30 
$2,250 

0.40 
2,700 

0.30 
3,150 
Assuming that EBIT equals 10% of sales, calculate earnings per share (EPS) under the debt financing and the stock financing alternatives at each possible level of sales. Round your answers to two decimal places. Write out your answer completely. For example, 0.00013 million should be entered as 130.
ANNUAL SALES 
EPS under 
EPS under 

$2,250 
$ ________ 
$ ________ 

??2,700 
$ ________ 
$ ________ 

??3,150 
$ ________ 
$ ________ 
Calculate expected EPS under both debt and stock financing alternatives. Round your answers to two decimal places. Write out your answer completely. For example, 0.00013 million should be entered as 130.
Under the debt financing expected EPS is $ ________
Under the stock financing expected EPS is $ ________
Calculate σ_{EPS} under both debt and stock financing alternatives. Round your answers to two decimal places. Write out your answer completely. For example, 0.00013 million should be entered as 130.
Under the dept financing σ_{EPS} is $ ________
Under the stock financing σ_{EPS} is $ ________
Calculate the debttocapital ratio and the timesinterestearned (TIE) ratio at the expected sales level under each alternative. The old debt will remain outstanding. [Hint: Notes payable should be included in both the numerator and the denominator of the debttocapital ratio.] Round your answers to two decimal places.
Under the debt financing.
The debt ratio is 
________ % 
Timesinterestearned ratio is 
________ 
Under the stock financing.
The debt ratio is 
________ % 
Timesinterestearned ratio is 
________ 
Which financing method do you recommend?
_________________
6. Risk analysis
a. Given the following information, calculate the expected value for Firm C's EPS. Data for Firms A and B are as follows: E(EPS_{A}) = $5.10, and σ_{A} = $3.59; E(EPS_{B}) = $4.20, and σ_{B} = $2.95. Round your answer to two decimal places.
Probability 

0.1 
0.2 
0.4 
0.2 
0.1 

Firm A: EPS_{A} 
($1.65) 
$1.80 
$5.10 
$8.40 
$11.85 
Firm B: EPS_{B} 
(1.20) 
1.31 
4.20 
7.09 
9.60 
Firm C: EPS_{C} 
(2.53) 
1.35 
5.10 
8.85 
12.73 
b.
$ ________
c. You are given that σ_{c} = $4.12. Discuss the relative riskiness of the three firms' earnings using their respective coefficients of variation. Round your answer to two decimal places.
CV 

A 
________ 
B 
________ 
C 
________ 
d.
The most risky is _________________
7. Financial leverage effects
The Neal Company wants to estimate next year's return on equity (ROE) under different leverage ratios. Neal's total capital is $18 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federalplusstate tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4.3 million with a 0.2 probability, $3.4 million with a 0.5 probability, and $600,000 with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debttocapital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.
Debt/Capital ratio is 0.
RÔE = 
________ % 
σ = 
________ % 
CV = 
________ 
Debt/Capital ratio is 10%, interest rate is 9%.
RÔE = 
________ % 
σ = 
________ % 
CV = 
________ 
Debt/Capital ratio is 50%, interest rate is 11%.
RÔE = 
________ % 
σ = 
________ % 
CV = 
________ 
Debt/Capital ratio is 60%, interest rate is 14%.
RÔE = 
________ % 
σ = 
________ % 
CV = 
________ 
8. Hamada equation
Cyclone Software Co. is trying to establish its optimal capital structure. Its current capital structure consists of 35% debt and 65% equity; however, the CEO believes the firm should use more debt. The riskfree rate, r_{RF}, is 6%; the market risk premium, RP_{M}, is 7%; and the firm's tax rate is 40%. Currently, Cyclone's cost of equity is 12%, which is determined by the CAPM. What would be Cyclone's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? Round your answer to two decimal places.
________ %
9. Breakeven analysis
A company's fixed operating costs are $750,000, its variable costs are $2.15 per unit, and the product's sales price is $5.15. What is the company's breakeven point; that is, at what unit sales volume will its income equal its costs? Round your answer to the nearest whole.
________ units
10. Financial leverage effects
Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $17 million in invested capital, has $5.1 million of EBIT, and is in the 40% federalplusstate tax bracket. Firm HL, however, has a debttocapital ratio of 60% and pays 12% interest on its debt, whereas LL has a 40% debttocapital ratio and pays only 9% interest on its debt. Neither firm uses preferred stock in its capital structure.
a. Calculate the return on invested capital (ROIC) for each firm. Round your answers to two decimal places.
ROIC for firm LL is ________ %
ROIC for firm HL is ________ %
b. Calculate the rate of return on equity (ROE) for each firm. Round your answers to two decimal places.
ROE for firm LL is ________ %
ROE for firm HL is ________ %
c. Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debttocapital ratio from 40% to 60%, even though that would increase LL's interest rate on all debt to 15%. Calculate the new ROE for LL. Round your answer to two decimal places.
________ %
Subject  Business 
Due By (Pacific Time)  11/30/2013 12:00 am 
Tutor  Rating 

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