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A B C D E F G H I
13 Case model
PART A
EBIT $400,000
PART C
Total capital for both firms $20,000
Tax rate for both firms 25%
TOTAL CAPITAL $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
EQUITY $20,000 $20,000 $20,000 $10,000 $10,000 $10,000
PROBABILITY 0.25 0.50 0.25 0.25 0.50 0.25
SALES $6,000 $9,000 $12,000 $6,000 $9,000 $12,000
ROIC 7.50% 11.25% 15.00% 7.50% 11.25% 15.00%
E(ROIC) 11.25% 11.25%
E(ROE) 11.25% 13.50%
Chapter 13. Capital Structure and Leverage
Consider two small hypothetical firms, Firm U, with zero debt financing, and Firm L, with $10,000 of 12% debt.
Both firms have $20,000 in invested capital and a 25% federal-plus-state tax rate.
9/12/2022 17:20
FIRM U
12/9/2018
(3) What is the firm’s return on invested capital (ROIC)?
FIRM L
This spreadsheet model is designed to be used in conjunction with the chapter’s integrated case and the related
PowerPoint slide presentation.
(1) Complete the partial income statements and the firms’ ratios.
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A B C D E F G H I
PART D
The cost of debt at different debt levels :
Amount D / Capital D / E Bond
Borrowed Ratio Ratio Rating
rd
$0 0.0000 0.0000 — —
$250,000 0.1250 0.1429 AA 8.0%
Sales (last year) $1,100,000
Variable costs as a % of sales 60%
Fixed costs $40,000
EBIT $400,000
At D = $0
At D = $250,000
Shares repurchased = 10,000
Remaining shares = 70,000
At D = $500,000
Shares repurchased = 20,000
Remaining shares = 60,000
(3) Assume that shares could be repurchased at the current market price of $25 per share. Calculate CD’s
expected EPS and TIE at debt levels of $0, $250,000, $500,000, $750,000, and $1,000,000. How many shares
would remain after recapitalization under each scenario?
The analysis for each debt level being considered (in thousands of dollars and shares) is shown below:
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A B C D E F G H I
At D = $750,000
Shares repurchased = 30,000
Shares repurchased = 40,000
Remaining shares = 40,000
rRF 7.5%
RPM6.0%
βu1.25
Total capital $2,000,000
Tax rate 25%
Amount D / Capital D / E Levered
Borrowed Ratio Ratio Beta
rs
$0 0.0000 0.0000 1.25 15.00%
Amount D / Capital E / Capital D / E Levered
Borrowed Ratio Ratio Ratio Beta
rsrdrd (1 – T) WACC
$0 0.00% 100.00% 0.00% 1.25 15.00% — — 15.00%
$250,000 12.50% 87.50% 14.29% 1.38 15.80% 8.0% 6.00% 14.58%
Amount Stock
Borrowed DPS rsprice
$0 $3.75 15.00% $25.00
(4) Using the Hamada equation, what is the cost of equity if CD recapitalizes with $250,000 of debt? $500,000?
$750,000? $1,000,000?
(5) What is the capital structure that minimizes CD’s WACC?
(6) What would be the new stock price if CD recapitalizes with $250,000 of debt? $500,000? $750,000?
$1,000,000? Recall that the payout ratio is 100%, so g = 0.
At D = $1,000,000