Homework answers / question archive / Acct 352 Question #1) Union Brick Inc, has a total market value of 200 million, consisting of 2 million shares of common stock selling for $50 per share and $100 million of 10% perpetual bonds currently selling at par

Acct 352 Question #1) Union Brick Inc, has a total market value of 200 million, consisting of 2 million shares of common stock selling for $50 per share and $100 million of 10% perpetual bonds currently selling at par

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Acct 352 Question #1) Union Brick Inc, has a total market value of 200 million, consisting of 2 million shares of common stock selling for $50 per share and $100 million of 10% perpetual bonds currently selling at par.  UBI pays out all earnings as dividends, and its marginal tax rate is 40%.  The firm's earnings before interest and taxes (EBIT) are $30 million.  Management is considering increasing UBI's debt to $140 million by calling in all the old bonds and issuing new debt with a 12% coupon, which sells at par.  The additional funds will be used to repurchase stock at the new equilibrium price.  If UBI's financial leverage is increased as described, the required rate of return of common equity will increase to 15%.

REQUIRED:

a)            What is UBI's current required rate of return on equity?

b)            What would be the value of the firm if the capital structure change were made? Should UBI make the proposed change and why?

                V = D + (EBIT - I) (1 - T)

                                                k

c)            What is the new stock price and how many shares can be repurchased?