Chat with us, powered by LiveChat The purpose of this assignment is to analyze a firm's capital structure and its impact on firm performance. Explain core concepts related to business risk, and recommend sound fin - Writeedu

The purpose of this assignment is to analyze a firm’s capital structure and its impact on firm performance. Explain core concepts related to business risk, and recommend sound fin

The purpose of this assignment is to analyze a firm's capital structure and its impact on firm performance. Explain core concepts related to business risk, and recommend sound financial decisions based on analysis of a firm's capital structure and capital budgeting techniques.

Read the Chapter 15 Mini Case in Financial Management: Theory and Practice. Complete Parts 1 and 2.

Part 1: Using complete sentences and academic vocabulary, please answer questions A through C.

Part 2: Using the mini case information, write a 250-word recommendation of the financial decisions you propose for this company based on an analysis of its capital structure and capital budgeting techniques. Explain why you chose this recommendation and how it will impact the performance of the firm.

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Chapter 15: Capital Structure Decisions Mini Case Book Title: Financial Management: Theory and Practice Printed By: Gregory Dayes ([email protected]) © 2020 Cengage Learning, Cengage Learning

Chapter Review

Mini Case

Assume you have just been hired as a business manager of PizzaPalace, a regional pizza restaurant chain. The company’s EBIT was $120 million last year and is not expected to grow. PizzaPalace is in the 25% state-plus-federal tax bracket, the risk-free rate is 6 percent, and the market risk premium is 6 percent. 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. If the company were to recapitalize, then debt would be issued, and the funds received would be used to repurchase stock. 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


0% —

20 8.0%

30 8.5

40 10.0

50 12.0

a. Using the free cash flow valuation model, show the only avenues by which capital structure can affect value.

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b. What is business risk? What factors influence a firm’s business risk?

What is operating leverage, and how does it affect a firm’s business risk? Show the operating break-even point if a company has fixed costs of $200, a sales price of $15, and variable costs of $10.

c. Explain the difference between financial risk and business risk.

d. To illustrate the effects of financial leverage for PizzaPalace’s management, consider two hypothetical firms: Firm U (which uses no debt financing) and Firm L (which uses $4,000 of 8% interest rate debt). Both firms have $20,000 in net operating capital, a 25% tax rate, and an expected EBIT of $2,400.

Construct partial income statements, which start with EBIT, for the two firms.

Calculate NOPAT, ROIC, and ROE for both firms.

What does this example illustrate about the impact of financial leverage on ROE?

Why did leverage increase ROE in this example?

e. What happens to ROE for Firm U and Firm L if EBIT falls to $1,600? What happens if EBIT falls to $1,200? What is the after-tax cost of debt? What does this imply about the impact of leverage on risk and return?

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.

g. What does the empirical evidence say about capital structure theory? What are the implications for managers?

h. With the preceding points in mind, now consider the optimal capital structure for PizzaPalace.

For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC.

Now 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 be issued, the resulting market value of equity, the price per share, the number of shares repurchased, and the

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