All work must be shown, preferably in Excel.
Scenario 1. Chris is the owner, president, and primary salesperson for Tarrytown, Inc.. Because of this, the company’s profits are driven by the amount of work Chris does. If he works 40 hours each week, the company’s EBIT will be $595,000 per year; if he works a 50-hour week, the company’s EBIT will be $715,000 per year. The company is currently worth $3.65 million. The company needs a cash infusion of $1.75 million, and it can issue equity or issue debt with an interest rate of 7 percent. Assume there are no corporate taxes.
| a. |
What are the cash flows to Chris under each scenario? (Enter your answers in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations.) |
| Scenario-1 | |
| Debt issue: |
| Cash flows | |
| 40-hour week | $ |
| 50-hour week | $ |
| Scenario-2 |
| Equity issue: |
| Cash flows | |
| 40-hour week | $ |
| 50-hour week | $ |
| b. | Under which form of financing is Chris likely to work harder? | |||
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Scenario 2: Chris’s company has an EBIT of $1,020,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 12 percent, and the corporate tax rate is 35 percent. The company also has a perpetual bond issue outstanding with a market value of $2.01 million.
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What is the value of the company? (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations and round your answer to 2 decimal places (e.g., 32.16).) |
| c. Value of the company | $ |
Scenario 3.
Tarrytown, Inc., has debt outstanding with a face value of $5 million. The value of the firm if it were entirely financed by equity would be $18.4 million. The company also has 470,000 shares of stock outstanding that sell at a price of $31 per share. The corporate tax rate is 35 percent. Chris needs to know what is the decrease in the value of the company due to expected bankruptcy costs?(Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)
| d. Financial distress costs | $ |
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