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    Capital Structure and Leverage Assignment

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    Faisal Farooqui
    This document contains 4 questions regarding capital structure and leverage for various companies. Question 1 involves calculating leverage metrics for DeSoto Tools before and after an expansion and constructing pro forma income statements with alternative financing options. Question 2 involves calculating valuation and WACC for Rogers Company under its current and an adjusted capital structure. Question 3 asks for the break-even quantity for Shapland Inc. Question 4 asks for the value of equity for Nichols Corporation after a recapitalization involving debt issuance and stock buyback.

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    Capital Structure and Leverage Assignment

    Uploaded by

    Faisal Farooqui
    71 views2 pages
    This document contains 4 questions regarding capital structure and leverage for various companies. Question 1 involves calculating leverage metrics for DeSoto Tools before and after an expansion and constructing pro forma income statements with alternative financing options. Question 2 involves calculating valuation and WACC for Rogers Company under its current and an adjusted capital structure. Question 3 asks for the break-even quantity for Shapland Inc. Question 4 asks for the value of equity for Nichols Corporation after a recapitalization involving debt issuance and stock buyback.

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    This document contains 4 questions regarding capital structure and leverage for various companies. Question 1 involves calculating leverage metrics for DeSoto Tools before and after an expansion and constructing pro forma income statements with alternative financing options. Question 2 involves calculating valuation and WACC for Rogers Company under its current and an adjusted capital structure. Question 3 asks for the break-even quantity for Shapland Inc. Question 4 asks for the value of equity for Nichols Corporation after a recapitalization involving debt issuance and stock buyback.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    71 views2 pages

    Capital Structure and Leverage Assignment

    Uploaded by

    Faisal Farooqui
    This document contains 4 questions regarding capital structure and leverage for various companies. Question 1 involves calculating leverage metrics for DeSoto Tools before and after an expansion and constructing pro forma income statements with alternative financing options. Question 2 involves calculating valuation and WACC for Rogers Company under its current and an adjusted capital structure. Question 3 asks for the break-even quantity for Shapland Inc. Question 4 asks for the value of equity for Nichols Corporation after a recapitalization involving debt issuance and stock buyback.

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    of 2

    CAPITAL STRUCTURE AND LEVERAGE

    ASSIGNMENT

    1. DeSoto Tools Inc. is planning to expand production. The expansion will cost $4,400,000,
    which can be financed either by bonds at an interest rate of 6 percent or by selling 88,000
    shares of common stock at $50 per share. The current income statement before expansion is
    as follows:
    DeSoto Tools Inc. Income Statement 202X
    Sales. $ 3,260,000
    Variable costs 1,304,000
    Fixed costs 824,000
    Earnings before interest and taxes $ 1,132,000
    Interest expense 640,000
    Earnings before taxes $ 492,000 Taxes (@ 40%) 196,800
    Earnings after taxes $ 295,200
    Shares 340,000
    Earnings per share $ .87
    After the expansion, sales are expected to increase by $1,740,000. Variable costs will remain
    at 40 percent of sales, and fixed costs will increase to $1,398,000. The tax rate is 40 percent.
    a. Calculate the degree of operating leverage, the degree of financial leverage, and the degree
    of combined leverage before expansion. (For the degree of operating leverage, use the
    formula: DOL = (S -TVC) / (S - TVC - FC). For the degree of combined leverage, use the
    formula: DCL = (S - TVC) / (S - TVC - FC - I). These instructions apply throughout this
    problem.) (Round your answers to 2 decimal places.)
    b. Construct the income statement for the two alternative financing plans. (Input all amounts
    as positive values. Round EPS to 2 decimal places.)
    c. Calculate the degree of operating leverage, the degree of financial leverage, and the degree
    of combined leverage, after expansion. (Round your answers to 2 decimal places.)

    Solution:
    2. The Rogers Company is currently in this situation: (1) EBIT = $4.7 million; (2) tax rate, T =
    40%; (3) value of debt, D = $2 million; (4) r d = 10%; (5) rs = 15%; (6) shares of stock
    outstanding, n = 600,000; and stock price, P = $30.
    The firm’s market is stable and it expects no growth, so all earnings are paid out as
    dividends. The debt consists of perpetual bonds.
    a. What is the total market value of the firm’s stock, S, and the firm’s total market value, V?
    b. What is the firm’s weighted average cost of capital?
    c. Suppose the firm can increase its debt so that its capital structure has 50% debt, based on
    market values (it will issue debt and buy back stock). At this level of debt, its cost of equity
    rises to 18.5% and its interest rate on all debt will rise to 12% (it will have to call and refund
    the old debt). What is the WACC under this capital structure? What is the total value? How
    much debt will it issue, and what is the stock price after the repurchase? How many shares
    will remain outstanding after the repurchase?
    3. Shapland Inc. has fixed operating costs of $500,000 and variable costs of $50 per unit. If it
    sells the product for $75 per unit, what is the break-even quantity?
    4. Nichols Corporation’s value of operations is equal to $500 million after a recapitalization
    (the firm had no debt before the recap). It raised $200 million in new debt and used this to
    buy back stock. Nichols had no short-term investments before or after the recap. After the
    recap, wd = 40%. What is S (the value of equity after the recap)?

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