2008 07 19 132822 Rivoli Essay

Submitted By Rockland19120
Words: 357
Pages: 2

a- What effect would this use of leveragehave on the value of the firm Original value of the firm (D 0) V D S 0 (15)(200,000) 3,000,000. Original cost of capital WACC wd rd(1-T) wers 0 (1.0)(10) 10. With financial leverage (wd30) WACC wd rd(1-T) wers (0.3)(7)(1-0.40) (0.7)(11) 8.96. Because growth is zero, the value of the company is V EMBED Equation.3 . Increasing the financial leverage by adding 900,000 of debt results in an increase in the firms value from 3,000,000 to 3,348,214.286. b- What would be the price of Rivolis stock Using its target capital structure of 30 debt, the company must have debt of D wd V 0.30(3,348,214.286) 1,004,464.286. Therefore, its debt value of equity is S V D 2,343,750. Alternatively, S (1-wd)V 0.7(3,348,214.286) 2,343,750. The new price per share, P, is P S (D D0)/n0 2,343,750 (1,004,464.286 0)/200,000 16.741. c- What happens to the firms earnings per share after the recapitalization The number of shares repurchased, X, is X (D D0)/P 1,004,464.286 / 16.741 60,000.256 ( 60,000. The number of remaining shares, n, is n 200,000 60,000 140,000. Initial position EPS (500,000 0)(1-0.40) / 200,000 1.50. With financial leverage EPS (500,000 0.07(1,004,464.286))(1-0.40) / 140,000 (500,000 70,312.5)(1-0.40) / 140,000 257,812.5 / 140,000 1.842. Thus, by adding debt, the firm increased its EPS by 0.342. d- The 500,000 EBIT givenpreviously is actually the expected…