Reference no: EM133034072
Question - Assume you have just been hired as a manager of CoffeePlace, a coffee shop located near Asoke junction. The company's earnings before interest and taxes (EBIT) was 100,000 baht last year, and it is expected to remain constant (in real terms) over time. CoffeePlace plans to pay out all profits as dividends. The management group owns about 50 percent of the stock.
The firm is currently all-equity financed; it has 20,000 shares outstanding; and current price is 5 baht per share. When you took your MBA corporate finance course, your instructor explained that most firms' owners could be better off financially if the firms used some debt. When you suggested this to your new boss, he encouraged you to follow up with the idea. As a first step, you consulted with the firm's investment banker and obtained the following estimated costs of debt for the firm at different capital structures:
|
Percent Financed with Debt
|
Costs of Debt
|
|
0%
|
0
|
|
20
|
7.0%
|
|
30
|
7.5
|
|
40
|
9.0
|
|
50
|
11.0
|
If the company were to recapitalize, debt would be issued, and the funds received would be used to repurchase stock. CoffeePlace is in the 20 percent corporate tax bracket, its beta is 1.0, the risk-free rate is 3 percent, and the market risk premium is 5 percent.
Consider capital structure effects (by identifying the ways in which capital structure can affect the weighted average cost of capital and free cash flows). Then discuss whether you agree with the following hypotheses and why:
1. Does the company's debt policy create value to the firm?
2. Does the company's debt policy create competitive advantage?
3. Does the company's debt policy sustain senior management's visions?