Question: You have just been hired as the Chief Financial Officer (CFO) of the Ski Shop, a chain of ski equipment stores. The CEO has asked that your first project be an evaluation of the firm's capital structure. The Ski Shop has expanded aggressively in recent years and its debt ratio has increased substantially. In fact, it now exceeds the ratios of other firms in the industry. You have determined that a change in capital structure that involves issuing $300 million of new equity and using it to retire long-term debt would put the company's leverage in line with that of others in the industry. You have been asked to prepare an analysis of the issue and make a recommendation.
Provide answers to the following questions:
a) What are the company's current equity value, firm value, and the debt-to-equity ratio?
b) Assume that after recapitalization, the equity value increases by $50 million, in addition to the $300 million new equity issue. What would be the equity value, firm value, and the debt-to-equity ratio after the recapitalization is completed?
You then estimate that the lower debt ratio would result in the firm's debt rating to improve from B to AAA.
c) What is the firm's current (before recapitalization) WACC?
d) What would the firm's WACC be following the recapitalization? Does it make sense to do the recapitalization?