King Inc. is an all-equity firm with 5,000 outstanding shares. Its firm value is $250,000 and EBIT is $36,000 per year forever. The tax rate is 40%. King is considering two recapitalization plans. Plan A: borrow $125,000 perpetual debt at 5% interest to repurchase stocks and the present value of bankruptcy costs is estimated to be $0. Plan B: borrow $160,000 perpetual debt at 8% interest to repurchase stocks and the present value of bankruptcy costs is estimated to be $7,500 (a) Calculate the equity value, cost of equity, weight average cost of capital, stock price after recapitalization plan A. (b) Calculate the equity value, cost of equity, weight average cost of capital, stock price after recapitalization plan B. (c) Calculate the breakeven EBIT of the two recapitalization plans.
King Inc. is an all-equity firm with 5,000 outstanding shares. Its firm value is $250,000 and
EBIT is $36,000 per year forever. The tax rate is 40%. King is considering two recapitalization
plans.
Plan A: borrow $125,000 perpetual debt at 5% interest to repurchase stocks and the present value
of bankruptcy costs is estimated to be $0.
Plan B: borrow $160,000 perpetual debt at 8% interest to repurchase stocks and the present value
of bankruptcy costs is estimated to be $7,500
(a) Calculate the equity value,
recapitalization plan A.
(b) Calculate the equity value, cost of equity, weight average cost of capital, stock price after
recapitalization plan B.
(c) Calculate the breakeven EBIT of the two recapitalization plans.
can you answer question c?
a and b is solved:
a) Plan A: equity value = $125,000, cost of equity= 12.9%, weight average cost of capital= 6.465, stock price after recapitalization plan A = $ 25 per share (b) Plan B: equity value= $90,000, cost of equity= 11.33%, weight average cost of capital= 4.1%, stock price after recapitalization plan B = $ 18 per share
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