Financial Management

Chapter 2 – Part 1
Firms’ Capital Structure (without taxes)

HOMEWORK

1. In a world with no taxes, consider an all-equity firm. The face value of the shares is 15€ and
the book value of equity is 225 million euros. The company does not have own shares in
treasury.

a) If the annual EBIT is constant and equal to 36 million euros and the required return
on equity is 12%, compute the market value of equity and the price per share.

b) Management is considering a change in the financing structure of the firm by issuing

100M€ in perpetual debt paying interests at 7%. The firm wants to use the proceedings
from the debt issue to distribute an extraordinary dividend. Compute the dividend per
share, the new value of equity after the dividend has been paid, and the new price per
share (assume the M&M world).

c) Suppose that you are an investor that has 10 shares of this company. What was the
value of your total wealth before the firms’ transaction? And after? Explain.

d) Given the new debt ratio (D/E) and the interest on debt of 7%, determine the new
expected return on equity. Is it different from the one before the transaction? Explain.

2. In a world with no taxes, a firm has 30M shares trading at a market price of 15€ per share,
and debt with a market value of 104 M€.

a) Draw the balance sheet of this company including the assets, the debt, the equity,
and the total value of the firm.

b) The company decides to issue new debt to repurchase 1 M shares. Draw the balance
sheet of the company after this transaction. Compare the value of debt, the value of
equity and total firm vale before and after the transaction.

3. In a world with no taxes, a company presents the following investment summary:

Financing mode Book value Market value Cost

Debt 3,000,000 2,800,000 4.8%
Common shares 1,108,000 2,500,000 13%

Determine this company’s weighted average cost of capital.