Question

Piedmont Printing Company has a total market value of $180 million, consisting of 1 million shares selling for $90 per share and $90 million of 9% perpetual bonds now selling at par. The company's EBIT is $35 million, and its tax rate is 25%. Piedmont can change its capital structure by either increasing its debt to 70% or decreasing it to 30%. If it decides to increase its use of leverage, it must call its old bonds and replace them with new ones with a 11% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 7% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. The firm pays out all earnings in dividends; hence, its stock is a zero-growth stock. Its current cost of equity is 13%. If it increases leverage, the cost of equity will be 15%. If it decreases leverage, the cost of equity will be 11%. What is the total corporate value if Piedmont decreases its leverage? $255,474,453 $283,018,868 $171.232.877 $215,517,241

Answer 1

DATE DATE ODITI [aßitil Structure (Exishly? Answer Source of funds o n Debt Equity C9r. per petuel] .. Market Value $ 90 millim $90 million 186 million da EBIT =358 million Tax = 25$ to Existing (ke) = 134 cilj Sirence of 2 8a Debt Market value proposed capital structure (14 deverife deerease] funds (7% Coupon) tal: 0-30 0:70 _ inline to 1.00 if Equity i Pooposed (ke) Cest dl Equity = 11. (i deverage decremes) Ippoposed) lace (1-tax) (1-257.) Wenke to Wawek = oito (8) 11% (2 0.30(2 7%. = 1.7% 1.57ST. z 9.2754._ Scatter w > (Wacc = 9.8751. CH Leverafe deercased to 30%)

DATE ODI Computation of free cash flow (if Leverage decrease) EBIT = 35 million $ 6) tax @ 95. = (8.75 million $ EBIT (Netol - tax) 26.15 million $ of free cash flow value of firm = free cash flows WACC (for zero growth company 26.275 million 9.2754. = 283.018868 millim # or 283018868 # Hence the correct answer is (b) $283,018, 868 Ics Scanned with -CamScanner