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EBIT ( 1t c )
R0
28,000
=250,000
0.112
A) Yes, I would recommend that company A goes ahead with the restructuring;
by restructuring, the company is able to increase the value by
V L V U =30,000
B)
V 'L
, the value of
company taking into account the cost financial distress PV ( CFD ) , is still
greater than
10,0003944.78=6055.22
2)
A) Scenario with dividends.
EPS=
Earnings 2000
=
=2
Shares
1000
P 19
= =9.5
E 2
Scenario with Repurchase
100,000
=3944.78
25.35
1000
=50
20
2000 40
= 2.1052632
950 19
P 20 19
= = =9.5
E 40 2
19
P/E ratio under both scenarios is identical and equal to 9.5
B) A share repurchase gives more flexibility to the shareholders, allowing
shareholders who desire to sell their share to do so. The dividend option may
not be as desirable, as it would be taxed at the top marginal rate at a point in
time the shareholder has no control over.
3)
B
=0.56 R s=0.12 RB =0.04 t c =0.4
S
EBIT ( millions )=22.20.4=8.88
EAT ( millions )=8.88( 1t C ) =8.88(10.4 )=5.328
A)
Rwacc =
S
B
1
0.56
Rs+
R B ( 1t c )=
0.12+
0.040.6=0.085538
S+ B
S+ B
1.56
1.56
UCF=EAT =5.328
V L=
B)
UCF
5.328
=
=62.287 ( millions)
R wacc 0.085538
UCF=LCF + ( 1t C ) R B B=LCF + ( 1t C )
V
( 0.56
1.56 )
5.328=LCF + 0.60.04
LCF=5.328
R BB
V
S+ B L
0.60.040.56
62.287=4.791373538( millions)
1.56
Value of equity=
LCF 4.791374538
=
=39.92811282( millions)
Rs
0.12
C) The two valuations methods can be used to obtain the same results, although
the procedures are quite different.
For WACC method, we find the cash flows of the unlevered (all-equity) firm
and discount those cash flows using
method we find the value of the Levered cash flows and discount them using
Rs . To show the results are the same if the value of debt, which is
22.3594359 in millions is added to the value of equity calculated above in
part B we obtain the same value of 62.287 (in millions).
Value of debt=
62.287=22.3594359 ( millions )
( 0.56
1.56 )
Value of debt +Value of equity ( part B ) =62.287 ( 3 decimal places )=asnwer for part A=Valueusing wac
4)
Cost of
Debt
after tax
c
1t
RB
Require
d return
Rs
WACC
Formula for calculating WACC used
below
B
S
Rwacc = R B ( 1t c ) + R s
V
V
0%
0.00
0.120
Rwacc =00+10.12=0.12
20%
0.0325
0.121
40%
0.065
0.128
Rwacc =0.40.065+0.60.128=0.1028
60%
0.0975
0.135
Rwacc =0.60.0975+0.40.135=0.1125
Rwacc
UCF / R wacc
0.12
0.1033
0.1028
0.1125
2062500.00
2395934.17
2407587.55
2200000.00
The Debt ratio that maximizes value is a debt ratio of 40%. Id therefore recommend
the company use a debt ratio of 40% if they are interested in maximizing value.