Gioanni Inc., has GH¢1 million in earnings before interest and taxes. Currently it is all-equity-financed. It may issue GH¢3 million in perpetual debt at 15 percent interest in order to repurchase stock, thereby recapitalizing the corporation. There are no personal taxes. If the corporate tax rate is 40 percent, what is the income available to all security holders if the company remains all-equity-financed? If it is recapitalized? What is the present value of the debt tax-shield benefits? The equity capitalization rate for the company’s common stock is 20 percent while it remains all-equity-financed. What is the value of the firm if it remains all-equity financed? What is the firm’s value if it is recapitalized?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question 7
Gioanni Inc., has GH¢1 million in earnings before interest and taxes. Currently it is all-equity-financed. It may issue GH¢3 million in perpetual debt at 15 percent interest in order to repurchase stock, thereby recapitalizing the corporation. There are no personal taxes.
- If the corporate tax rate is 40 percent, what is the income available to all security holders if the company remains all-equity-financed? If it is recapitalized?
- What is the
present value of the debt tax-shield benefits? - The equity capitalization rate for the company’s common stock is 20 percent while it remains all-equity-financed. What is the value of the firm if it remains all-equity financed? What is the firm’s value if it is recapitalized?
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