Concept explainers
The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
- a. What is Rivoli’s intrinsic value of operations (i.e., its unlevered value)? What is its intrinsic stock price? Its earnings per share?
- b. Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its
cost of equity , rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Based on the new capital structure, what is the new weighted average cost of capital? What is the levered value of the firm? What is the amount of debt? - c. Based on the new capital structure, what is the new stock price? What is the remaining number of shares? What is the new earnings per share?
a)
To determine: Company R’s intrinsic value of operations and intrinsic stock price and its earnings per share.
Explanation of Solution
Calculation of original value of operations:
Original free cash flow:
Hence, original cash flow is $450,000
Original cost of capital:
Hence, original cost of capital is 10%
Original value of operations:
Hence, original value of operations is $4,500,000
Calculation of intrinsic value of stock price:
Therefore, intrinsic stock price is $22.50
Calculation of original EPS:
Therefore, the original EPS is $2.25
b)
To determine: New WACC, levered value of the firm and the amount of debt.
Explanation of Solution
Calculation of WACC:
At 30% debt,
Hence, weighted average cost of capital of company R is 9.975%
Therefore, new beta is 11.0528%
Calculation of value of operations:
Leverage doesn’t change the cash flows, so the value of levered firm based on new WACC is as follows,
Hence, the value of operations is $4,511,278.195
Calculation of amount of debt:
Hence, the amount of debt is $1,353,383.459
c)
To determine: New stock price, remaining number of shares and new earnings per share based on new capital structure.
Explanation of Solution
Calculation of new stock price:
Therefore, the stock price after repurchase is equal to $22.5564
Calculation of total number of shares after repurchased:
Therefore, the number of remaining shares is 200,000-60,000 = 140,000
Calculation of earnings per share (EPS):
Therefore, the new earnings per share of company is $2.71
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Chapter 15 Solutions
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