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Point 1: Saleem Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $20.24 million, and its tax rate is 15%. Saleem can change its capital structure either by increasing its debt to 55% (based on market values) or decreasing it to 25%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 8% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change.
Question 1: The firm pays out all earnings as dividends; hence its stock is a zero-growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 17%. If it decreases leverage, rs will be 12%. What is the firm's WACC and total corporate value under each capital structure?
How will what you learned in this problem help you determine an investment and variable costing Plant assets:
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