Home / Questions / Volunteer Fabricators Inc VF currently has zero debt It is a zero growth company and it h...
Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth
company, and it has the data shown below. Now the company is considering using
some debt, moving to the market value capital structure indicated below. The
money raised would be used to repurchase stock. It is estimated that the increase
in risk resulting from the additional leverage would cause the required rate of
return on equity to rise somewhat, as indicated below.
EBIT = $80,000 New Debt/Value = 20%
Growth = 0% New Equity/Value = 80%
Orig cost of equity, rs = 10.0% No. of shares = 10,000
New cost of equity = rs = 11.0% Price per share = $48.00
Tax rate = 40% Interest rate = rd = 7.0%
Part I:
If this plan were carried out, what would be VF's new WACC and its new value of
operations?
Part II:
Now assume that VF is considering changing from its original zero debt capital
structure to a new capital structure with even more debt. This results in changes in
the cost of debt and equity, and thus to a new WACC and a new value of
operations. Assume VF raises the amount of new debt indicated below and uses
the funds to purchase and hold T-bills until it makes the stock repurchase. What is
the stock price per share immediately after issuing the debt but prior to the
repurchase?
Debt/Value = 40% Value of new debt = $213,333
Equity/Value= 60% New WACC = 9.0%
Part III:
Based on the data in the previous two parts, what would the stock price be if VF
issued the new debt and immediately used the proceeds to repurchase stock?
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