{"id":11350,"date":"2021-10-27T02:02:27","date_gmt":"2021-10-27T02:02:27","guid":{"rendered":"https:\/\/assignmenttutors.net\/blog\/mackenzie-capital-budget-analysis-chapter-17-capital-structure-557\/"},"modified":"2021-10-27T02:02:27","modified_gmt":"2021-10-27T02:02:27","slug":"mackenzie-capital-budget-analysis-chapter-17-capital-structure-557","status":"publish","type":"post","link":"https:\/\/assignmenttutors.net\/blog\/mackenzie-capital-budget-analysis-chapter-17-capital-structure-557\/","title":{"rendered":"Mackenzie capital budget analysis.- chapter 17 capital structure 557"},"content":{"rendered":"
\n

\u00a0<\/span><\/strong><\/p>\n

Chapter 17<\/span><\/p>\n

Capital Structure <\/span><\/p>\n

557<\/span><\/p>\n

www.mhhe.com\/rwj<\/span><\/p>\n

remain unlevered forever. If OPC does not retire the debt, the company will use the <\/span><\/p>\n

$2.5 million in cash to buy back some of its stock on the open market. Repurchasing <\/span><\/p>\n

stock also has no transaction costs. The company will generate $1,300,000 of annual <\/span><\/p>\n

earnings before interest and taxes in perpetuity regardless of its capital structure. <\/span><\/p>\n

The firm immediately pays out all earnings as dividends at the end of each year. <\/span><\/p>\n

OPC is subject to a corporate tax rate of 35 percent, and the required rate of return <\/span><\/p>\n

on the firm\u2019s unlevered equity is 20 percent. The personal tax rate on interest income <\/span><\/p>\n

is 25 percent, and there are no taxes on equity distribution. Assume there are no <\/span><\/p>\n

bankruptcy costs. <\/span><\/p>\n

a.<\/span><\/p>\n

What is the value of OPC if it chooses to retire all of its debt and become an <\/span><\/p>\n

unlevered firm? <\/span><\/p>\n

b.<\/span><\/p>\n

What is the value of OPC if is decides to repurchase stock instead of retiring its <\/span><\/p>\n

debt? <\/span><\/p>\n

( <\/span><\/p>\n

Hint:<\/span><\/p>\n

Use the equation for the value of a levered firm with personal tax on inter-<\/span><\/p>\n

est income from the previous problem.) <\/span><\/p>\n

c.<\/span><\/p>\n

Assume that expected bankruptcy costs have a present value of $400,000. How <\/span><\/p>\n

does this influence OPC\u2019s decision? <\/span><\/p>\n

McKENZIE CORPORATION\u2019S CAPITAL BUDGETING <\/span><\/p>\n

Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional com-<\/span><\/p>\n

pany. Sam is considering opening several new restaurants. Sally Thornton, the company\u2019s <\/span><\/p>\n

CFO, has been put in charge of the capital budgeting analysis. She has examined the <\/span><\/p>\n

potential for the company\u2019s expansion and determined that the success of the new restau-<\/span><\/p>\n

rants will depend critically on the state of the economy over the next few years. <\/span><\/p>\n

McKenzie currently has a bond issue outstanding with a face value of $29 million that <\/span><\/p>\n

is due in one year. Covenants associated with this bond issue prohibit the issuance of any <\/span><\/p>\n

additional debt. This restriction means that the expansion will be entirely financed with <\/span><\/p>\n

equity at a cost of $5.7 million. Sally has summarized her analysis in the following table, <\/span><\/p>\n

which shows the value of the company in each state of the economy next year, both with <\/span><\/p>\n

and without expansion: <\/span><\/p>\n

Economic <\/span><\/p>\n

Growth Probability<\/span><\/p>\n

Without <\/span><\/p>\n

Expansion With Expansion<\/span><\/p>\n

Low .30 $25,000,000 $27,000,000<\/span><\/p>\n

Normal .50 30,000,000 37,000,000<\/span><\/p>\n

High .20 48,000,000 57,000,000<\/span><\/p>\n

1. <\/span><\/p>\n

What is the expected value of the company in one year, with and without expansion? <\/span><\/p>\n

Would the company\u2019s stockholders be better off with or without expansion? Why? <\/span><\/p>\n

2. <\/span><\/p>\n

What is the expected value of the company\u2019s debt in one year, with and without the <\/span><\/p>\n

expansion? <\/span><\/p>\n

3. <\/span><\/p>\n

One year from now, how much value creation is expected from the expansion? How <\/span><\/p>\n

much value is expected for stockholders? Bondholders? <\/span><\/p>\n

4. If the company announces that it is not expanding, what do you think will happen to <\/span><\/p>\n

the price of its bonds? What will happen to the price of the bonds if the company does <\/span><\/p>\n

expand? <\/span><\/p>\n

558<\/span><\/p>\n

Part IV<\/span><\/p>\n

Capital Structure and Dividend Policy<\/span><\/p>\n

www.mhhe.com\/rwj<\/span><\/p>\n

5. <\/span><\/p>\n

If the company opts not to expand, what are the implications for the company\u2019s future <\/span><\/p>\n

borrowing needs? What are the implications if the company does expand? <\/span><\/p>\n

6. Because of the bond covenant, the expansion would have to be financed with equity. <\/span><\/p>\n

How would it affect your answer if the expansion were financed with cash on hand <\/span><\/p>\n

instead of new equity? <\/span><\/p>\n

Some Useful Formulas of Financial Structure <\/span><\/p>\n

The Miller Model and the Graduated <\/span><\/p>\n

Income Tax <\/span><\/p>\n

To access the appendixes for this chapter, please visit www.mhhe.com\/rwj. <\/span><\/p>\n

\u00a0<\/span><\/strong><\/p>\n

\u00a0<\/span><\/strong><\/p>\n

\u00a0<\/span><\/strong><\/p>\n

\u00a0<\/span><\/strong><\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

\u00a0 Chapter 17 Capital Structure 557 www.mhhe.com\/rwj remain unlevered forever. If OPC does not retire the debt, the company will use the $2.5 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $1,300,000 of annual earnings before interest and […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[31],"tags":[],"class_list":["post-11350","post","type-post","status-publish","format-standard","hentry","category-homework-help"],"_links":{"self":[{"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/posts\/11350","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/comments?post=11350"}],"version-history":[{"count":0,"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/posts\/11350\/revisions"}],"wp:attachment":[{"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/media?parent=11350"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/categories?post=11350"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/assignmenttutors.net\/blog\/wp-json\/wp\/v2\/tags?post=11350"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}