Question Details

What is Milbrett- expected earnings per share following the recapitalization 



Currently, the Fotopoulos Corporation- balance sheet is as follows:

Assets 	$5 billion	Debt	$1 billion
	          		Common equity	 4 billion
Total assets	$5 billion	Total debt & common equity	$5 billion

The book value of the company (both debt and common equity) equals its market value (both debt and common equity).  Furthermore, the company has determined the following information:

•	The company estimates that its before-tax cost of debt is 7.5 percent.
•	The company estimates that its levered beta is 1.1.
•	The risk-free rate is 5 percent.
•	The market risk premium, kM - kRF, is 6 percent.
•	The company- tax rate is 40 percent.

In addition, the Fotopoulos Corporation is considering a recapitalization.  The proposed plan is to issue $1 billion worth of debt and to use the money to repurchase $1 billion worth of common stock.  As a result of this recapitalization, the firm- size will not change.

 .	What is Fotopoulos’ current WACC (before the proposed recapitalization)?

a.	 5.92%
b.	 9.88%
c.	10.18%
d.	10.78%
e.	11.38%

 .	What is Fotopoulos’ current unlevered beta (before the proposed recapitalization)?

a.	0.6213
b.	0.8962
c.	0.9565
d.	1.0041
e.	1.2700

 .	What will be the company- new cost of common equity if it proceeds with the recapitalization?  (Hint:  Be sure that the beta you use is carried out to 4 decimal places.)

a.	10.74%
b.	11.62%
c.	12.27%
d.	12.62%
e.	13.03%

(The following information applies to the next two problems.)

An analyst has collected the following information regarding the Milbrett Corporation:

•	Total assets = $100 million.
•	Basic earning power (BEP) = 20%.
•	Tax rate = 40%.

Currently, the company has no debt or preferred stock and its interest expense and preferred dividends equal zero.  The book value and market value of common equity equals $100 million.  The company has 5 million outstanding shares of common stock, and its stock price is $20 a share.

Milbrett is considering a recapitalization, where they will issue $20 million of debt and use the proceeds to buy back common stock at the current price of $20 a share.  As a result of the recapitalization, the size of the firm will not change.  Assume that the newly-issued debt will have a before-tax cost of 
8 percent.  Assume that the recapitalization will have no effect on the company- basic earning power.

 .	Which of the following is likely to occur following the recapitalization?

a.	The company- net income will increase.
b.	The company- ROA will increase.
c.	The company- operating income will decrease.
d.	The company- ROE will increase.
e.	None of the statements above is correct.

 .	Assume that after the recapitalization the company- times-interest-earned ratio will be 12.5.  What is Milbrett- expected earnings per share following the recapitalization ?

a.	$2.44
b.	$2.62
c.	$2.76
d.	$2.80
e.	$2.88




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