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Calculation Of Weighted Average Cost Of Capital After Restructuring With Discounted Cash Flows

Question

Green Manufacturing Inc. plans to announce that it will issue $2,000,000 of perpetual bonds. The bonds will have a 6% coupon rate. Green Manufacturing currently is an all equity financed firm with 500,000 shares outstanding. After the sale of the bonds, Green will retire part of its existing stock, and will maintain the new capital structure indefinitely. The firm expects to generate constant annual pre-tax earnings of $1,500,000 in the foreseeable future. Green is in the 40% tax bracket and its current cost of equity equals 9%. Based on this information, answer the following 6 questions:

(i) What is Green Manufacturing’s current stock price?

(ii) Construct Green Manufacturing’s market value balance sheet just before the announcement of the debt issue.

(iii) What is the new stock price after the announcement of the recapitalization and how many shares of stock will Green retire?

(iv) Construct the market value balance sheet after the restructuring has taken place.

(v) What is Green’s cost of equity and cost of capital (WACC) after the restructuring?

(vi) Verify the value of the firm after the restructuring by discounting the cash flows at the new WACC.

 

Summary

The question belongs to Finance and it discusses about calculation of weighted average cost of capital and calculating the value of the firm after restructuring with discounted cash flows.

Total Word Count 221

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