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The Rivoli Company has no debt outstanding, and its financial position is given by the following data: Expected EBIT $600,000 Growth rate in EBIT, gL0% Cost of equity, rs10% Shares outstanding, 200,000 Tax rate, T (federal-plus-state)25% What is Rivoli's intrinsic value of operations (i
The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
Expected EBIT $600,000
Growth rate in EBIT, gL0%
Cost of equity, rs10%
Shares outstanding, 200,000
Tax rate, T (federal-plus-state)25%
What is Rivoli's intrinsic value of operations (i.e., its unlevered value)? Round your answer to the nearest dollar.
What is its intrinsic stock price? Its earnings per share? Round your answers to the nearest cent.
Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 40% debt based on market values, its cost of equity, rs, will increase to 11% to reflect the increased risk. Bonds can be sold at a cost, rd, of 9%. Based on the new capital structure, what is the new weighted average cost of capital? Round your answer to three decimal places.
What is the levered value of the firm? What is the amount of debt? Do not round intermediate calculations. Round your answers to the nearest dollar.
Based on the new capital structure, what is the new stock price? Do not round intermediate calculations. Round your answer to the nearest cent.
What is the remaining number of shares? Do not round intermediate calculations. Round your answer to the nearest whole number.
What is the new earnings per share? Do not round intermediate calculations. Round your answer to the nearest cent.
Expert Solution
Computation of the value of unlevered firm:-
Value of unlevered firm = EBIT*(1-Tax rate) / Cost of equity
= $600,000*(1-25%) / 10%
= $450,000 / 10%
= $4,500,000
Computation of the intrinsic stock price:-
Intrinsic stock price = Value of unlevered firm / Number of shares outstanding
= $4,500,000 / 200,000
= $22.50 per share
Computation of the earnings per share (EPS):-
EPS = Earnings after tax / Number of shares outstanding
= $600,000*(1-25%) / 200,000
= $450,000 / 200,000
= $2.25 per share
Computation of the new weighted average cost of capital (WACC):-
New WACC = (Weight of debt*After tax cost of debt) + (Weight of equity*Cost of equity)
= (40%*9%*(1-25%)) + (60%*11%)
= 2.70% + 6.60%
= 9.300%
Computation of the value of levered firm:-
Value of levered firm = EBIT*(1-Tax rate) / WACC
= $600,000*(1-25%) / 9.30%
= $450,000 / 9.30%
= $4,838,709.68
Computation of the amount of debt:-
Amount of debt = Value of levered firm * Weight of debt
= $4,838,709.68 * 40%
= $1,935,483.87
Computation of the new stock price:-
New stock price = Value of levered firm / Number of shares outstanding
= $4,838,709.68 / 200,000
= $24.19 per share
Computation of the remaining number of shares:-
Number of shares repurchased = Amount of debt / New stock price
= $1,935,483.87 / $24.19
= 80,000 shares
Remaining shares = 200,000 - 80,000
= 120,000 shares
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