Viable Enterprises, Inc. is seeking to float a new bond to pay for an expansion of the firm intothe Midwest. However, some directors fear that the increase in bankruptcy risk might begreater than any benefits from Viable expanding into new markets. You have been tasked bythe CFO with estimating current bankruptcy risks, and you have decided to start bycalculating some simple default models. Shares outstanding for Viable are 0.53 million, andmarket price per share is $10.98. Using the table below, what is the Altman Z-Score (show 2decimal places)?CurrentAssetsTotalAssetsCurrent$12,414 EBIT$5,804Retained$43,416$17,028Earnings$8,467LiabilitiesTotal$14,459LiabilitiesSales$98,769

Calculating Altman Z-Score for Viable Enterprises:Step 1: Calculate RatiosWorking Capital Ratio =…

Answered: Viable Enterprises, Inc. is seeking to…

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter15: Capital Structure Decisions

Section: Chapter Questions

Problem 8P

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The Rivoli Company has no debt outstanding, and its financial position is given by the following data: What is Rivoli’s intrinsic value of operations (i.e., its unlevered value)? What is its intrinsic stock price? Its earnings per share? Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Based on the new capital structure, what is the new weighted average cost of capital? What is the levered value of the firm? What is the amount of debt? Based on the new capital structure, what is the new stock price? What is the remaining number of shares? What is the new earnings per share?
General Electric Capital, a division of General Electric, uses long-term debt extensively. In a recent year, GE Capital issued 11 billion in long-term debt to investors, then within days filed legal documents to prepare for another 50 billion long-term debt issue. As a result of the 50 billion filing, the price of the initial 11 billion offering declined (due to higher risk of more debt). Bill Gross, a manager of a bond investment fund, denounced a lack in candor related to GEs recent debt deal. It was the most recent and most egregious example of how bondholders are mistreated. Gross argued that GE was not forthright when GE Capital recently issued 11 billion in bonds, one of the largest issues ever from a U.S. corporation. What bothered Gross is that three days after the issue the company announced its intention to sell as much as 50 billion in additional debt, warrants, preferred stock, guarantees, letters of credit and promissory notes at some future date. In your opinion, did GE Capital act unethically by selling 11 billion of long-term debt without telling those investors that a few days later it would be filing documents to prepare for another 50 billion debt offering? Source: Jennifer Ablan, Gross Shakes the Bond Market; GE Calms It, a Bit, Barrons, March 25, 2002.
Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 51.5% debt (wd) by issuing bonds and using the proceeds to repurchase and retire some common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity, i.e., what is rL - rU? Do not round your intermediate calculations. Risk-free rate, rRF 5.00% Tax rate, T 25% Market risk prem, RPM 4.00% Current wd 0% Current beta, bU 1.20 Target wd 51.5% 4.78% 3.06% 4.40% 3.63% 3.82%
In the Enron case, the company eventually turned to “back-door” guaranteeing of the debt of Chewco, one of its SPEs, to satisfy equity investors. Assume that a $16 million loan agreement required that Enron stock should not fall below $40 per share. If the share price did decline below that trigger amount, either the loan would be called by the bank or the bank could choose to increase the guaranteed number of Enron shares based on the new price (assume $32). If the bank decides to increase the number of shares guaranteed, what would be (1) the original number of shares in the guarantee and (2) the new number of shares? Why would it be important from an accounting and ethical perspective for Enron to disclose information about the guarantee in its financial statements?
You own stocks in an oil palm plantation company, and you read in the financial press that a recent bond offering has raised the firm’s debt-equity ratio from 30 percent to 55 percent. Discuss the effect of this change on the variability of the firm’s net income stream. Discuss how this change would affect your required rate of return on the common stock of the company. Provide your justification(s) to support your views in the answer space provided.
The total market value of the common stock of the Okefenokee Real Estate Company is $11.5 million, and the total value of its debt is $7.5 million. The treasurer estimates that the beta of the stock is currently 1.8 and that the expected risk premium on the market is 7%. The Treasury bill rate is 3%. Assume for simplicity that Okefenokee debt is risk-free and the company does not pay tax. Suppose the company wants to diversify into the manufacture of rose-colored spectacles. The beta of unleveraged optical manufacturers is 1.05. Estimate the required return on Okefenokee's new venture. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
WorldTrans currently finances with 20.0% debt (i.e., wd = 20%), but its new CFO is considering changing the capital structure so wd = 62.5% by issuing additional bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity? Do not round your intermediate calculations. (Hint: You must unlever the current beta and then use the unlevered beta to solve the problem.) Risk-free rate, rRF 5.00% Tax rate, T 25% Market risk prem, RPM 6.00% Current wd 20% Current beta, bL1 1.60 Target wd 62.5% Group of answer choices 10.93% 9.18% 11.39% 9.64% 11.48%
Koffman Corporation is trying to raise capital. What method would be the least risky to raise capital if it has a less-than-favorable credit rating? A. Stock issuance, since a credit rating won’t negatively affect Koffman’s ability to sell stock. B. With low credit, Koffman doesn't have any options for raising capital. C. Bond issuance, since nobody wants to buy shares of a company with a less-than-perfect credit rating. D. Bond issuance, since additional debt can provide the company with more leverage.
The common stock and debt of Northern Sludge are valued at $66 million and $34 million, respectively. Investors currently require a return of 15.6% on the common stock and 8.1% on the debt. If Northern Sludge issues an additional $17 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes (do not round intermediate calculations. Enter your answer as a percent rounded to two decimal places).
Appliances, Inc. has no debt outstanding, and its financial position is given by the following data: Assets (market value = book value) $5,000,000 EBIT $800,000 Cost of equity 12% Stock price $10 Shares outstanding 500,000 Tax rate 25% The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 20% debt based on market values, its cost of equity will increase to 13% to reflect the increased risk. Bonds can be sold at a cost of 6%. Appliance, Inc. is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time. As a creditor, you are concerned about the company’s ability to repay its debt and interest. What is the new times interest earned?
Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Statement 2: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote’s value. Elona’s Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? Group of answer choices Statement 1: Pecking order theory; Statement 2: Static trade-off theory Statement 1: MM’s propositions; Statement 2: Pecking order theory Statement 1: Static trade-off theory; Statement 2: MM’s propositions Statement 1: MM’s propositions; Statement 2: Static trade-off theory
Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Statement 2: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote’s value. Elona’s Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? Group of answer choices Statement 1: Pecking order theory; Statement 2: Static trade-off theory Statement 1: MM’s propositions; Statement 2: Pecking order theory Statement 1: Static trade-off theory; Statement 2: MM’s propositions Statement 1: MM’s propositions; Statement 2: Static trade-off theory PreviousNext

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