--%>
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 : Determine weighting of shares done and

    When computing the WACC, is the weighting of the shares done and the debt with book values of debt and shareholder’s equity or along with market values?

    		•
  • Q : Abnormal profits based on fundamental

    If it is possible to make abnormal profits based on fundamental analysis, you can conclude that the market is: A) Not weak-form efficientB) Weak-form efficientC) Not semi-strong-form efficientD) Semi-strong-form e

    		•
  • Q : Explain few Spanish mutual funds

    Is this true that very little Spanish mutual funds outperform their benchmark? Isn’t this strange?

    		•
  • Q : Expected return and standard deviation

    If an investor is considered to be risk-averse, what is his/her attitude towards expected return and standard deviation?

    		•
  • Q : What is Net Operating Profit after Tax

    What is Net Operating Profit after Tax (NOPAT)?

    		•
  • Q : All rates are stated annually with

    1 Assume the following (all rates are stated annually with semiannual compounding) a. Six Month Spot Rate is 2% b. Six Month Forward rate starting at month six is 2.2% c. Six Month Forward rate starting at month 12 is 2.4% d. Six Month Forward rate starting at mont

    		•
  • Q : Zurich Pvt Ltd. You have joined Zurich

    You have joined Zurich Pvt. Ltd as a Finance manager. You are given the following information: Zurich Pvt Ltd. is a diversified manufacturing firm dealing with electrical appliances. In 2012, the firm reported an operating income of Rs. 857.60 million and faced a tax rate of 35% on income. The firm

    		•
  • Q : Define stock variable Stock variable :

    Stock variable: It is a variable whose value is measured or evaluated at a point of time.

    		•
  • Q : How must we compute the beta and the

    How must we compute the beta and the risk premium?

    		•
  • 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

    		•