Using the free cash flow valuation model

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Reference no: EM131949224

Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The company’s EBIT was $50million last year and is not expected to grow. The firm is currently financed with all equity,and it has 10million shares outstanding.When you took your corporate finance course,your instructor stated that most firms ’owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm’s investment banker the following estimated costs of debt for the firm at different capital structures: PERCENT FINANCED WITH DEBT, Wd rd 0% - 20 8.0% 30 8.5 40 10.0 50 12.0 If the company were to recapitalize, then debt would be issued and the funds received would be used to repurchase stock. PizzaPalace is in the 40% state-plus-federal corprate tax bracket, its beta is 1.0, the risk free rate is 6%, and the market risk premium is 6%. Using the free cash flow valuation model, show the only avenues by which capital structure can affect value.

Reference no: EM131949224

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