Question Assignment 8 Problem 1

29 Jun Question Assignment 8 Problem 1

Question

Assignment 8

Problem 1

Lowell Inc. has no debt and its financial position is given by the

following data:

Assets (book = market) $3,000,000

EBIT $500,000

Cost of equity (Ks) 10%

Stock price (P0) $15

Shares outstanding n0 200,000

Tax rate T 40%

The firm is considering selling bonds and simultaneously

repurchasing some of its stock. It if moves to capital structure

with 30 percent debt based on market values, its cost of equity,

Ks, will increase to 11 percent to reflect the increased risk.

Bonds can be sold at a cost (Kd) of 7 percent. Lowell Inc. is a

no-growth firm. Hence, all its earnings are paid out as

dividends, and earnings are exceptionally constant over time.

a.

A. What would be the new WACC?

B. What effect would this use of leverage have on the value of thefirm (Va)?

C.What would be Lowell Inc.’s stock price?

D.What happens to the firm’s earnings per share after therecapitalization?

Problem 2

Mass Inc. is trying to estimate its optimal capital

structure. Right now, Mass Inc. has a capital structure

that consists of 50 percent debt and 50 percent equity,

based on market values. (Its D/S ratio is 1.00) The riskfree

rate is 6 percent and the market risk premium, K

M–

K

RF, is 5 percent. Currently the company’s cost of equity,

which is based on the CAPM, is 12 percent and its tax rate

is 40 percent. What would be Mass Inc.’s estimated cost of

equity if it were to change its capital structure to 60 percent debt and 40 percent equity?

Problem 3

Use the following information to:

a. Calculate the cash conversion cycle, and interpret the

numbers

INCOME STATEMENT COCA-COLA PEPSI

Sales

23,104 32,562

Cost of goods sold

8,195 14,176

BALANCE SHEET COCA-COLA PEPSI

Assets

Cash and Cash Equivalents 4,701 1,716

Short-term Investments 66 3,166

Accounts Receivables 2,281 3,261

Inventory 1,424 1,693

Other Current Assets 1,778 618

Total Current Assets

10,250 10,454