As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate of use when evaluating the purchase of new packing equipment for the plant. You have determined the market value of the firm's capital structure as follows:
Source of Capital Market Values
Bonds 3,800,000
Preferred Stock $1,500,000
Common Stock $5,600,000
To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying 6.7% per year at the market price of $1073. Preferred Stock paying $2.07 dividend can be sold $25.53; Common Stock for Ranch Manufacturing is currently selling for $54.94 per share. The firm paid a $3.07 dividend last year and expects dividends to continue growing at a rate of 5.2% per year. The firm's tax rate is 30 percent. What is the WACC?
Abe Forrester and three of his friends from college have interested a group of venure capitalists in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service a full line ot vacuum cleaners and accessories. These stores would be located in Dallas, Houston, and San Antonio. To finance the new venture two plans have been propsed:
-Plan A is an all-common-equity structure which $2.4million dollars would be raised by selling 84,000 shares of common stock.
-Plan B would involve issuing $1.5 million dollars in long-term bonds with effective interest rate of 11.6% plus 0.9 million would be raised by selling 42,000 shares of common stock. The debt funds raised under Plan B have no fixed maturity date, in that this amount of financial leverage is considered a permanent part of the firms capital sturcture.
Abe and his partners plan to use a 34% tax rate in their analysis and they have hired you on a consulting basis to do the following:
A: Find the EBIT indifference level associated with the two financing plans.
B: Prepare a pro forma income statement for the EBIT level SOLVED for in Part A. that shows that EPS will be the same regardless whether Plan A or B is chosen.
Three recent graduates of the computer science program at the university of Tennessee are forming a company that will write and distribute new application software for the iPhone. Initially the corporation will operate in the southern region of Tennessee, Georgia, North Carolina, and South Carolina. A small group of private investors in the Atlanta, Georgia area is interested in financing the startup company and two financing plans have been put forth for consideration:
The first plan (plan A) is an all-common-equity capital structure. 2.3 million dollars would be raised by selling common stock at $20 per common share
- Plan B would involve the use of financial leverage. 1.2 million dollars would be raised by selling bonds with an effective interest rate of 10.8% (per annum) and the remaining 1.1 million would be raised by selling common stock at the $20 price per share. The use of financial leverage is considered to be a permanent part of the firms capitalization, so no fixed maturity date is needed for the analysis. A 30% tax rate is deemed appropriate for the analysis.
A. Find the EBIT indifference level associated with the two financial plans.
B. A detailed financial analysis of the firms prospects suggests that the long term EBIT will be above $329,000 annually. Taking this into consideration, which plan will generate the higher EPS?