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Capital Structure Numerical Problems

The document contains three numerical problems related to calculating return on equity and earnings per share under different capital structures, including all-equity versus mixed debt/equity structures. The first problem involves a company called MEC considering issuing debt and repurchasing shares. The second problem involves a company called APC considering a similar recapitalization plan. It asks to calculate various metrics under the current and proposed structures. The third problem involves a company called CSC considering a recapitalization plan and calculates expected earnings per share and return on equity under different economic scenarios.

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peter parkar
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89 views2 pages

Capital Structure Numerical Problems

The document contains three numerical problems related to calculating return on equity and earnings per share under different capital structures, including all-equity versus mixed debt/equity structures. The first problem involves a company called MEC considering issuing debt and repurchasing shares. The second problem involves a company called APC considering a similar recapitalization plan. It asks to calculate various metrics under the current and proposed structures. The third problem involves a company called CSC considering a recapitalization plan and calculates expected earnings per share and return on equity under different economic scenarios.

Uploaded by

peter parkar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Capital Structure Numerical Problems

1. As Chief Financial Officer of the Magnificent Electronics Corporation (MEC), you


are considering a recapitalization plan that would convert MEC from its current all-
equity capital structure to one including substantial financial leverage. MEC now has
500,000 shares of common stock outstanding, which are selling for $60 each, and you
expect the firm’s EBIT to be $2,400,000 per year for the foreseeable future. The
recapitalization proposal is to issue $15,000,000 worth of long-term debt at an interest
rate of 6.0 percent and use the proceeds to repurchase 250,000 shares of common
stock worth $15,000,000. Assuming there are no market frictions such as corporate or
personal income taxes, calculate the expected return on equity for MEC shareholders
under both the current all-equity capital structure and under the recapitalization plan.

2. The All-Star Production Corporation (APC) is considering a recapitalization plan that


would convert APC from its current all-equity capital structure to one including some
financial leverage. APC now has 10,000,000 shares of common stock outstanding,
which are selling for $40.00 each, and you expect the firm’s EBIT to be $50,000,000
per year for the foreseeable future. The recapitalization proposal is to issue
$100,000,000 worth of long-term debt at an interest rate of 6.50 percent and use the
proceeds to repurchase as many shares as possible at a price of $40.00 per share.
Assume there are no market frictions such as corporate or personal income taxes.
Calculate the expected return on equity for APC shareholders under both the current
all-equity capital structure and under the recapitalization plan.
a. Calculate the number of shares outstanding and the debt-to-equity ratio for APC if
the proposed recapitalization is adopted.
b. Calculate the earnings per share (EPS) and return on equity for APC shareholders
under both the current all-equity capitalization and the proposed mixed
debt/equity capital structure.
c. Calculate the break-even level of EBIT where earnings per share for APC
stockholders are the same under the current and proposed capital structures.
d. At what level of EBIT will APC shareholders earn zero EPS under the current and
the proposed capital structures?

3. As Chief Financial Officer of the Campus Supply Corporation (CSC), you are
considering a recapitalization plan that would convert CSC from its current all-equity
capital structure to one including substantial financial leverage. CSC now has 250,000
shares of common stock outstanding, which are selling for $60.00 each, and the
recapitalization proposal is to issue $7,500,000 worth of long-term debt at an interest
rate of 6.0 percent and use the proceeds to repurchase 125,000 shares of common
stock worth $7,500,000. CSC’s earnings next year will depend on the state of the
economy. If there is normal growth, EBIT will be $2,000,000; EBIT will be
$1,000,000 if there is a recession and EBIT will be $3,000,000 if there is an economic
boom. You believe that each economic outcome is equally likely. Assume there are
no market frictions such as corporate or personal income taxes.
a. Calculate the number of shares outstanding, the per-share price and the debt-to-
equity ratio for CSC if the proposed recapitalization is adopted.
b. Calculate the expected earnings per share (EPS) and return on equity for CSC
shareholders under all three economic outcomes (recession, normal growth and
boom), for both the current all-equity capitalization and the proposed mixed
debt/equity capital structure.
c. Calculate the break-even level of EBIT where earnings per share for CSC
stockholders are the same under the current and proposed capital structures.
d. At what level of EBIT will CSC shareholders earn zero EPS under the current and
the proposed capital structures?

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