Assignment Analyzing a Firms Capital Structure

Case Assignment
Analyzing a Firms Capital Structure
Mr. Hillbrandt has learned a lot about the financial side of running the
business during the first year with the company and is now contemplating
making changes to the corporate capital structure. He needs your
assistance one more time.
ABC Golf Equipment Corporation has $10 million in assets (where the
market value of the assets is equal to the book value of the assets) and no
debt. The company’s marginal tax rate is currently 35% and has 500,000
shares outstanding. The company’s earnings before interest and taxes
(EBIT) are $3.88 million. The firm’s stock price is $27 per share and the
cost of equity is 11%.
The company is thinking of issuing bonds and simultaneously repurchasing
a portion of its stock. If the company changes its capital structure from no
debt to 25% debt based on market values, the firm’s cost of equity will
increase to 13% because of the increased risk. The bonds can be sold at
a cost of 9%. The firm’s earnings are not expected to grow over time. All
of its earnings will be paid out as dividends.
Probability EBIT ($)
0.05 – 1 million
0.25 2.3 million
0.40 4 million
0.25 5.8 million
0.05 6.1 million
Listen
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Required:
Computations (use Excel).
Make the computations necessary to answer the questions below. Don’t
forget that Mr. Hillbrandt does appreciate your step-by-step computations
to guide him through the analysis.
1. What impact will this utilization of this debt have on the value of the
company?
2. What’s going to be the company’s EPS after the recapitalization?
3. What’s going to be the company’s new stock price?
4. The $3.88 million EBIT discussed above is determined from this
probability distribution.
5. What’s the times interest earned ratio at each probability level?
Memo (use Word).
Interpret the analysis already prepared and use the Excel computations as
a basis for a memo to the CEO. Write a four or five paragraph memo.
Make sure each question listed above is addressed. Start with an
introduction and end with a recommendation. Each of the four or five
paragraphs should have a heading.
Short Essay (use Word).
Do research to determine some significant considerations that go into
selecting or changing the capital structure of a corporation. Start with an
introduction and end with a summary or conclusion. Use headings. Don’t
forget to reference your sources. Maximum length of two pages.
Assignment Expectations
Each submission should include two files: (1) An Excel file; and (2) A Word
document. The Word document shows the memo first and short essay last.
Assume a knowledgeable business audience and use required format and
length. Individuals in business are busy

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