Question

Suppose that a company's equity is currently selling for $27.25 per share and that there are 4.3 million shares outstanding and 23 thousand bonds outstanding, which are selling at 98 percent of par. If the firm was considering an active change to their capital structure so that the firm would have a D/E of 1.8, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell? (Round your intermediate ratio to 4 decimal places.)

rev: 09_25_2018_QC_CS-140244

$67,244,247 in new equity

$56,349,458 in new debt

$56,349,458 in new equity

$67,244,247 in new debt

Answer 1

Market value of equity (E ) = 4.3 million *$ 27.25 = $ 117.175 million

Market value of debt (D) = 23,000 *$1000 * 98% = $22.54 million (face value of bond is assumed at $1000)

Current D/E ratio = $22.54 million/$ 117.175 million = 0.1924

Total value of firm = Market value of equity + Market value of debt = $ 117.175 million +$22.54 million

= $139.715 million

Required D/E ratio = 1.8

Assume that new debt of the company is X

Therefore new equity = $139.715 million –X

Therefore

1.8 = X/ ($139.715 million –X)

Or 1.8 * ($139.715 million –X) = X

Or X = 1.8*$139.715 million /2.8 = $89.82 million

New value of debt = $89.82 million

Additional debt purchase = $89.82 million -$22.54 = $67,244,247

The company has to sell $67,244,247 in new debt