Problem Set: Capital Structure

Recapitalization
Question 1
Promto KPK Inc.s target capital structure is 20 percent debt, 5 percent preferred stock, and 75
percent common stock. Assume that the firms after-tax yield to maturity on its bond is 6 percent,
and that the investors require a 7.5 percent return on Promto preferred stock and a 15 percent
return on its common stock. What is Promto KPKs WACC?
Question 2
TCH Corporation is considering two alternative capital structures with the following
characteristics:
Debt/Asset Ratio
Kd

A
0.30
10%

B
0.70
14%

The firm will have total assets of RM500000, a tax rate of 40 percent, and a book value per share
of RM10, regardless of the capital structure. EBIT is expected to be RM200000 for the coming
years. What is the difference in earning per share (EPS) between the two alternatives?
Question 3
Last year BKatil Sdn. Bhd. had RM50 million in total assets. Management desires to increase its
plant and equipment during the coming years by RM12 million. The company plans to fianc 40
percent of the expansion with debt and the remaining 60 percent in equity capital. Bond financing
will be at 9 percent rate and will be sold at par value. Common stock is currently selling for RM50
per share, and flotation costs foe new common stock will amount to RM5 per share. The
expected dividend next year for BKatil is RM 2.50. Furthermore, dividend is expected to grow at
a 6 percent rate into the future. The marginal corporate tax rate is 28 percent. Internal funding
available from additions to retained earning is RM4000000.
a. What amount of new stock must be sold if existing capital structure is to be maintained?
b. Calculate the weighted marginal cost of capital at an investment level of RM12 million.
Question 4
AJCroft Sdn. Bhd. currently has RM200,000 debt outstanding carrying a coupon rate of 6 percent.
Its earnings before interest and taxes (EBIT) are RM100,000, and it is a zero-growth company.
The companys cost of equity is 10 percent, and its tax rate is 27%. The company has 10,000
shares of common stock outstanding. The dividend payout ratio is 100%.
AJCroft Sdn. Bhd. Is considering recalling the 6 percent debt by issuing RM400,000 new 7
percent debt. The new funds would be used to replace the old debt and to repurchase stock at
the existing price. It is estimated that the increase in riskiness resulting from the leverage
increase would cause the required rate of return on equity to increase to 11 percent. If this plan is
carried out, what would be the companys new stock price?

Problem Set: Capital Structure

Recapitalization
Question 1
Promto KPK Inc.s target capital structure is 20 percent debt, 5 percent preferred stock, and 75
percent common stock. Assume that the firms after-tax yield to maturity on its bond is 6 percent,
and that the investors require a 7.5 percent return on Promto preferred stock and a 15 percent
return on its common stock. What is Promto KPKs WACC?
Question 2
TCH Corporation is considering two alternative capital structures with the following
characteristics:
Debt/Asset Ratio
Kd

A
0.30
10%

B
0.70
14%

The firm will have total assets of RM500000, a tax rate of 40 percent, and a book value per share
of RM10, regardless of the capital structure. EBIT is expected to be RM200000 for the coming
years. What is the difference in earning per share (EPS) between the two alternatives?
Question 3
Last year BKatil Sdn. Bhd. had RM50 million in total assets. Management desires to increase its
plant and equipment during the coming years by RM12 million. The company plans to fianc 40
percent of the expansion with debt and the remaining 60 percent in equity capital. Bond financing
will be at 9 percent rate and will be sold at par value. Common stock is currently selling for RM50
per share, and flotation costs foe new common stock will amount to RM5 per share. The
expected dividend next year for BKatil is RM 2.50. Furthermore, dividend is expected to grow at
a 6 percent rate into the future. The marginal corporate tax rate is 28 percent. Internal funding
available from additions to retained earning is RM4000000.
a. What amount of new stock must be sold if existing capital structure is to be maintained?
b. Calculate the weighted marginal cost of capital at an investment level of RM12 million.
Question 4
AJCroft Sdn. Bhd. currently has RM200,000 debt outstanding carrying a coupon rate of 6 percent.
Its earnings before interest and taxes (EBIT) are RM100,000, and it is a zero-growth company.
The companys cost of equity is 10 percent, and its tax rate is 27%. The company has 10,000
shares of common stock outstanding. The dividend payout ratio is 100%.
AJCroft Sdn. Bhd. Is considering recalling the 6 percent debt by issuing RM400,000 new 7
percent debt. The new funds would be used to replace the old debt and to repurchase stock at
the existing price. It is estimated that the increase in riskiness resulting from the leverage
increase would cause the required rate of return on equity to increase to 11 percent. If this plan is
carried out, what would be the companys new stock price?