--%>
Assignment Help - homework help

Financing EBIT problem

Rusk Inc needs $50 million in new capital that it might obtain by selling bonds at par with coupon of 12% or by selling stock at $40 (net) per share. The current capital structure of Rusk consists of $300 million (face value) of 10% coupon bonds selling at 90 and 10 million shares of stock selling at $43 apiece. Subsequent to the new financing, the EBIT of Rusk is expected to be $70 million with standard deviation of $30 million. Which technique of financing do you suggest? Determine the probability that you are correct?

E

Expert

Verified

From the given details,

When the issue of shares is involved, to raise $50 million at $40/share, the outstanding shares will increase by 1.25 million.

401_EBIt.jpg

As a result, the earnings available to common shareholders are higher under common stock alternative than they are under the debt alternative. Hence the financing method must be to raise $50 million by selling shares at $40 per share.

In order to determine the probability that this decision is right, we need the indifference point between the two alternatives.

((EBIT - $36)(1 – 0.4) – 0)/10 = ((EBIT - $30)(1 – 0.4) – 0)/11.25
11.25*(0.6 EBIT – 21.6) = 10*(0.6 EBIT – 18)
6.75 EBIT – 243 = 6 EBIT – 180
0.75 EBIT = 63
EBIT = $84 million

Hence the probability that the above decision is right is

Z = ($84 – 70)/30 = 0.467
P(z) = 67.96%

Thus the equity financing must be recommended and the probability that this is right is 67.96%.

   Related Questions in Corporate Finance

  • Q : Tax benefits of lease FedEx would like

    FedEx would like to acquire 300 vans for its business. It can buy each van for $35,000, depreciate it completely over 5 years, and then sell it for $10,000. The tax rate of FedEx is 30%, and its cost of debt is 10%. Avis Fleet Rental will lease these vans to FedEx for

    		•
  • Q : Define Credit and Collections Credit &

    Credit & Collections: Usually, credit is stated as the procedure of providing a loan, in which one party transfers wealth to the other with the expectation that it will be re-paid in full plus interest. The definition of collections is connected t

    		•
  • Q : Problem on Decision variables A factory

    A factory has three distinct systems for making similar product: System 1: Worker runs 3 machines of type-A, each of which costs $20 per day to run, each generates 100 units per day and the worker is paid $40 per day.System 2

    		•
  • Q : Problem on annual obligation payment

    ABC Corp. has a challenge: The CEO wants to set aside annual, end of year payments into a sinking fund account earning 5% over the next 6 years in order to retire $25 million in bonds that will be outstanding at that time. Determine the annual payment required each ye

    		•
  • Q : Which currency is utilized in an

    Which currency has to be utilized in an international acquisition in order to compute the flows?

    		•
  • Q : Which taxes do I have to use for

    Which taxes do I have to utilize when calculating Free Cash Flow (FCF) – is this the medium tax rate or the marginal tax rate of the leveraged company?

    		•
  • Q : Does it make sense to apply identical

    The National Company responsible for the company where he work has newly published a document stating as that the levered beta of the sector of energy transportation is as 0.471870073 (it is 9 decimals). They acquired this number by considering the betas into the sect

    		•
  • Q : Strategy of Bear Spread State when

    State when markets are anticipated to go down then what is the Strategy of Bear Spread?

    		•
  • Q : Expected return for a portfolio What is

    What is the expected return for a portfolio consisting of 200 shares of Nike, 200 shares of Home Depot, and 400 shares of Intel if their expected returns are 10%, 8% and 12% respectively, and their current prices are $25, $50, and $25 per share respec

    		•
  • Q : Determining Profitable purchasing ABC

    ABC Corporation is interested in purchasing a machine which will cost $50,000, and it will depreciate it on the straight-line basis over a 5-year period. The machine is predicted to last for 7 years and then Milan will sell it for $5,000. The expected earnings before

    		•