The Rogers Company is currently in this situation: (1) EBIT = $4.7 million; (2) tax rate T = 40%;

QUESTION

The Rogers Company is currently in this situation: (1) EBIT = $4.7 million; (2) tax rate, T = 40%; (3) value of debt, D = $2 million; (4) rd =
10%; (5) rs = 15%; (6) shares of stock outstanding, n0 = 600,000; and stock price, P0 = $30. The firm”s market is stable,
and it expects no growth, so all earnings are paid out as dividends. The debt consists of perpetual bonds.

a. What is the total market value of the firm”s stock, S, and the firm”s total market value, V?

b. What is the firm”s weighted average cost of capital?

c. Suppose the firm can increase its debt so that its capital structure has 50 percent debt, based on market values (it will issue debt and buy back
stock). At this level of debt, its cost of equity rises to 18.5 percent. Its interest rate on all debt will rise to 12 percent (it will have to call and
refund the old debt). What is the WACC under this capital structure? What is the total value? How much debt will it issue, and what is the stock price
after the repurchase? How many shares will remain outstanding after the repurchase?
a) Firms total market value (V) = (EBIT/WACC) (debt*tax rate)Value of equity = 600000*30 = 18000000 OR 18 mill., Total value of debt equity = 2 18 = 20 mill.WACC = (.10*2/20) (.15*18/20) = .145 or 14.5%Firms total market value (V) = 4.7/.145 (2*.40) = $33.214 mill.Firms market value of stock (S) = 33.214-2 = $31.214 Mill. b) WACC = 14.5% (calculated as above) c) WACC = (.12*.5) (.185*.5) = 15.25bt issue = 20*.50 = 10 mill (total debt),

ebt issue = 10-2 = 8 MillTotal value = 4.7/.1525 (10*.40) = $34.82 millShares outstanding after repurchase = 600000-8000000/30 = 333,333Stock price after repurchase: dividend/KeDividend = 4.7-(10*.12)*(1-.40) = 3.98 millDividend per share = 3.98/333333 = 11.94Price per share = 11.94/.185 = 64.54

ANSWER:

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