Assume you have just been hired as a business manager of pizzapalace.
EBIT was $ 50 million last year not expected to grow.
Currently financed with all Equity.
10 million shares outstanding.
You suggested to your boss to use the debt financing. Heapproved.
Estimated costs of debt for firm are below:
Percent Financed with Debt,wd rd
0% -
20 8.0%
30 8.5%
40 10.0%
50 12.0%
If the company were to recapitalize then debt would be issued andthe funds received would be used to repurchase stock.
federal tax bracket is 40%.
beta is 1.0
risk free rate is 6%
market risk premium is 6%
Required:
a. provide a brief overview of capital structure effects. be sureto identify the ways in which capital structure can affect the WACCand FCF
b. 1. what is business risk? what factors influence a firm'sbusiness risk?
2. what is operating leverage, and how does it affect a firm'sbusiness risk? show the operating break even point if a company hasfixed costs of $ 200, a sales price of $15.00 and variable costs of$ 10.00
c. develop an example to present to pizza palace use these twohypothetical firms:
Firm U
uses no debt financing
assets is $ 20,000
40% tax rate
EBIT is $3,000
Firm L:
uses debt financing
$ 10,000 of 12% debt
assets is $ 20,000
40% tax rate
EBIT is $ 3,000
1. construct partial income statement which starts with EBIT forboth firms
2.calculate ROE for both
3. what is the impact of financial leverage on both firms?
d. Explain the difference between financial risk and businessrisk.
e. what happens to ROE for Firm U and firm L if EBIT falls to $2000? what does this imply about the impact of leverage on risk andreturn?
f. what does capital structure theory attempt to do? what lessonscan be learned from capital structure theory? address MMmodels
g. what does the empirical evidence say about capital structuretheory? what are the implications for managers?
h. with the preceeding points in mind, now consider the optimalcapital structure for Pizza Palace.
1. for each capital structure under construction, calculate thelevered beta, the cost of equity and the WACC.
2. calculate the corporate value for each capital structure.
i. Describe the recapitalization process and apply it to PizzaPalace. Calculate the resulting value of the debt that will beissued, the resulting market value of equity the price per share,the number of shares repurchased, and the remaining shares.Considering only the capital structure under analysis, what isPizza Palace optimal structure?
Assume you have just been hired as a business manager of pizzapalace.
EBIT was $ 50 million last year not expected to grow.
Currently financed with all Equity.
10 million shares outstanding.
You suggested to your boss to use the debt financing. Heapproved.
Estimated costs of debt for firm are below:
Percent Financed with Debt,wd rd
0% -
20 8.0%
30 8.5%
40 10.0%
50 12.0%
If the company were to recapitalize then debt would be issued andthe funds received would be used to repurchase stock.
federal tax bracket is 40%.
beta is 1.0
risk free rate is 6%
market risk premium is 6%
Required:
a. provide a brief overview of capital structure effects. be sureto identify the ways in which capital structure can affect the WACCand FCF
b. 1. what is business risk? what factors influence a firm'sbusiness risk?
2. what is operating leverage, and how does it affect a firm'sbusiness risk? show the operating break even point if a company hasfixed costs of $ 200, a sales price of $15.00 and variable costs of$ 10.00
c. develop an example to present to pizza palace use these twohypothetical firms:
Firm U
uses no debt financing
assets is $ 20,000
40% tax rate
EBIT is $3,000
Firm L:
uses debt financing
$ 10,000 of 12% debt
assets is $ 20,000
40% tax rate
EBIT is $ 3,000
1. construct partial income statement which starts with EBIT forboth firms
2.calculate ROE for both
3. what is the impact of financial leverage on both firms?
d. Explain the difference between financial risk and businessrisk.
e. what happens to ROE for Firm U and firm L if EBIT falls to $2000? what does this imply about the impact of leverage on risk andreturn?
f. what does capital structure theory attempt to do? what lessonscan be learned from capital structure theory? address MMmodels
g. what does the empirical evidence say about capital structuretheory? what are the implications for managers?
h. with the preceeding points in mind, now consider the optimalcapital structure for Pizza Palace.
1. for each capital structure under construction, calculate thelevered beta, the cost of equity and the WACC.
2. calculate the corporate value for each capital structure.
i. Describe the recapitalization process and apply it to PizzaPalace. Calculate the resulting value of the debt that will beissued, the resulting market value of equity the price per share,the number of shares repurchased, and the remaining shares.Considering only the capital structure under analysis, what isPizza Palace optimal structure?
Related questions
Assume you have just been hired as a business manager ofPizzaPalace, a regional pizza restaurant chain. The companyâs EBITwas $50 million last year and is not expected to grow. The firm iscurrently financed with all equity, and it has 10 million sharesoutstanding. When you took your corporate finance course, yourinstructor stated that most firmsâ owners would be financiallybetter off if the firms used some debt. When you suggested this toyour new boss, he encouraged you to pursue the idea. As a firststep, assume that you obtained from the firmâs investment bankerthe following estimated costs of debt for the firm at differentcapital structures:
Percent Financed with Debt, | |
0% | â |
20 | 8.0% |
30 | 8.5 |
40 | 10.0 |
50 | 12.0 |
If the company were to recapitalize, then debt would be issuedand the funds received would be used to repurchase stock.PizzaPalace is in the 40% state-plus-federal corporate tax bracket,its beta is 1.0, the risk-free rate is 6%, and the market riskpremium is 6%. 1. a. What is business risk? What factors influencea firmâs business risk? b. What is operating leverage, and how doesit affect a firmâs business risk? Show the operating break-evenpoint if a company has fixed costs of $200, a sales price of $15,and variable costs of $10. Using complete sentences and academicvocabulary, please answer question. Please don't copy from othersources. Thank you
Assume you have just been hired as a business manager ofPizzaPalace, a regional pizza restaurant chain. The companyâs EBITwas $50 million last year and is not expected to grow. The firm iscurrently financed with all equity, and it has 10 million sharesoutstanding. When you took your corporate finance course, yourinstructor stated that most firmsâ owners would be financiallybetter off if the firms used some debt. When you suggested this toyour new boss, he encouraged you to pursue the idea. As a firststep, assume that you obtained from the firmâs investment bankerthe following estimated costs of debt for the firm at differentcapital structures:
Percent Financed with Debt, | |
0% | â |
20 | 8.0% |
30 | 8.5 |
40 | 10.0 |
50 | 12.0 |
If the company were to recapitalize, then debt would be issuedand the funds received would be used to repurchase stock.PizzaPalace is in the 40% state-plus-federal corporate tax bracket,its beta is 1.0, the risk-free rate is 6%, and the market riskpremium is 6%.
1. Using the free cash flow valuation model, show the onlyavenues by which capital structure can affect value.
Using complete sentences and academic vocabulary, please answerquestion. Please don't copy from other sources. Thank you
Intermediate Financial Management 11th Edition
Chapter 15: Capital Structure Decisions Part 1 Mini Case
Assume you have just been hired as a business manager of PizzaPalace, a regional pizze restaurant chain. The company EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms' owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm's investment banker the following estimated costs of debt for the firm at different capital structures:
| PERCENT FINANCED WITH DEBT, Wd | rd |
|---|---|
| 0% | - |
| 20 | 8.0% |
| 30 | 8.5 |
| 40 | 10.0 |
| 50 | 12.0 |
If the company were to recapitalize, then debt would be issued and the funds received would be used to repurchase stock. PizzaPalace is in the 40% state-plus-federal corprate tax bracket, its beta is 1.0, the risk free rate is 6%, and the market risk premium is 6%.
Please answer All Parts:
Part A: Provide a brief overview of capital structure effects. Be sure to identify the ways in which capital structure can affect the WACC and free cash flows.
Part B: 1) What is business risk? What factors influence a firm's business risk? 2) What is operating leverage, and how does it affect a firm's business risk? Show the operating breakeven point if a company has fixed costs of $200, a sales price of $15, and variable costs of $10.
Part C: Now, to develop an example that can be presented to PizzaPalace's management to illustrate the effects of financial leverage, consider two hypothetical firms: Firm U, which uses no debt financing, and Firm L, which uses $10,000 of 12% debt. Both firms have $20,000 in assets, a 40% tax rate, and an expected EBIT of $3,000. 1) Construct partial income statements, which start with EBIT, for the two firms. 2) Now calculate ROE for both firms. 3) What does this example illustrate about the impact of financial leverage on ROE?
Part D: Explain the difference between financial risk and business risk.
Part E: What happens to ROE for Firms U and L if EBIT falls to $2,000? What does this imply about the impact of leverage on risk and return?
Part F: What does capital structure theory attempt to do? What lessons can be learned from capital structure theory? Be sure to address the MM models.
Part G: What does the empirical evidence say about capital structure theory? What are the implications for managers?
Part H: With the preceding points in mind, now consider the optimal capital structure for PizzaPalace. 1) For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC. 2) Now calculate the corporate value for each capital structure.
Part I: Describe the recapitalization process and apply it to PizzaPalace. Calculate the resulting value of the debt that will be issued, the resulting market value of equity, the price per share, the number of shares repurchased, and the remaining shares. Considering only the capital structures under analysis, what is PizzaPalace's optimal capital structure?
