Capital Structure and Dividends (Case Study Sample)
Please use original writing.
Please provide reference that has a current URL and can be verified on the internet. Please use some references from the background information attached.
Please include the computations using Microsoft Excel utilizing the instructions below
Please use Microsoft Word to complete the Memo and the short essay using the instructions below strictly.
Analyzing a Firm’s Capital Structure
Mr. Hillbrandt has learned a lot about the financial side of running the business during the first year with the company and is now contemplating making changes to the corporate capital structure. He needs your assistance one more time.
ABC Golf Equipment Corporation has $10 million in assets (where the market value of the assets is equal to the book value of the assets) and no debt. The company’s marginal tax rate is currently 35% and has 500,000 shares outstanding. The company’s earnings before interest and taxes (EBIT) are $3.88 million. The firm’s stock price is $27 per share and the cost of equity is 11%.
The company is thinking of issuing bonds and simultaneously repurchasing a portion of its stock. If the company changes its capital structure from no debt to 25% debt based on market values, the firm’s cost of equity will increase to 13% because of the increased risk. The bonds can be sold at a cost of 9%. The firm’s earnings are not expected to grow over time. All of its earnings will be paid out as dividends.
Probability EBIT ($)
0.05 - 1 million
0.25 2.3 million
0.40 4 million
0.25 5.8 million
0.05 6.1 million
Computations (use Excel).
Make the computations necessary to answer the questions below. Don’t forget that Mr. Hillbrandt does appreciate your step-by-step computations to guide him through the analysis.
1. What impact will this utilization of this debt have on the value of the company?
2. What’s going to be the company’s EPS after the recapitalization?
3. What’s going to be the company’s new stock price?
4. The $3.88 million EBIT discussed above is determined from this probability distribution.
5. What’s the times interest earned ratio at each probability level?
Memo (use Word).
Interpret the analysis already prepared and use the Excel computations as a basis for a memo to the CEO. Write a four or five paragraph memo. Make sure each question listed above is addressed. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.
Short Essay (use Word).
Do research to determine some significant considerations that go into selecting or changing the capital structure of a corporation. Start with an introduction and end with a summary or conclusion. Use headings. Don’t forget to reference your sources. Maximum length of two pages.
Each submission should include two files: (1) An Excel file; and (2) A Word document. The Word document shows the memo first and short essay last. Assume a knowledgeable business audience and use required format and length. Individuals in business are busy and want information presented in an organized and concise manner.
FIN501 MOD4 CASE- Capital Structure and Dividends
TO: Mr. Hillbrandt, CEO ABC Golf Equipment Corporation
SUBJECT: Decision making in investment analysis
This memo focuses on the impact of debt on the firm’s value, the earning per share after the recapitalization and the new stock price. Additionally it will also highlight the times interest earned ratio for the different probability levels.
Debt and company’s valuation
Since the value of a firm is dependent on the equity and debt (V=E+D), the introduction of debt changes its value, and the after-tax cost influences the overall cost of capital. One of the changes is that that the cost of equity increases from 11% to 13%. However, there is increased risk in a firm given that the income then needs to be utilized in paying back the debt regardless of the state of cash flows or earnings. As such there is a need o understand how the leverage will affect the cost of equity as this is related to the level of risk in the company. Changing the capital structure to 75% equity and 25% debt, causes a decrease in the value of the firm since the WACC increases from 10% to 11.21%. The original value without a change in the capital structure is $ 22,927,273 and this then decreases to $22,492,754, representing a fall in value by $434, 519.
WACC = wsrs + wdrd(1-T) = (0.75) (13%) + (0.25)(9%)(1-0.35) = 0.112125 = 11.21%
Since the firm is unleveraged in the original position VL=VU in the original capital structure with no debt
FCF / WACC = EBIT (1-T) / WACC = $3,880,000 x 0.65 / 0.11= $ 22,927,273
After recapitalizing to 25% debt, the value of operations then changes to
FCF / WACC = EBIT (1-T) / WACC = $3,880,000 x 0.65 / 0.112125 = $22,492,754
EPS after the recapitalization
The EPS of ABC Golf Equipment Corporation is 5.83 calculated as follows
The initial position is= $3,880,000*0.65/500/000= $5.04
Net income (with 25% debt) = (EBIT – rdD) (1- T) = [$3,880,000 – (0.09) ($2,500,000)] (0.65)
= $ 2,375,750
Number of shares after stock repurchase = nPost = nPrior – (DNew – DOld) / PPrior
= 500,000 – ($2,500,000 / $27) = 407, 407
EPS = Net income / nPost EPS = $ 2,375,750/ 407, 407=$5.83
There is an increase in the EPS by $ 0.09
Company’s new stock price
The new stock price is dependent on the new value of the firm as well as the outstanding number of shares. Brigham & Daves (2013) provide the formula for the stock price is provided as PPost = (VopNew – DOld) / nPrior = $22,492,754/ 500,000= $44.99
The times interest earned ratio at each probability level
At 25% of debt level ABC Golf Equipment Corporation has a debt of $2,500,000 being 25%*10,000,000, while the rd is 9%, meaning that the annual interest rate is $2,500,000*9%= $ 225, 000.
YOU MAY ALSO LIKE
- ZZZZ Best Company, IncDescription: Ernst &Whinney never issued an audit on financial statements of ZZZZ Best but did issue report on the company’s quarterly statement for the three months ending July 1986...10 pages/≈2750 words | No Sources | APA | Accounting, Finance, SPSS | Case Study |
- The Ethical Temperature in ArcticviewDescription: Below is a case scenario that involves various Ethics and norms that we might find ourselves victims of one day...4 pages/≈1100 words | No Sources | APA | Accounting, Finance, SPSS | Case Study |
- Ratio Analysis and Ñomparison: University Of Washington Med.CenterDescription: Be able to provide written and oral communications on accounting information to non-financial orientated individuals as well as financially oriented individuals...2 pages/≈550 words | No Sources | APA | Accounting, Finance, SPSS | Case Study |