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Boston Textiles has an all-common-equity capital structure. Pertinent financial characteristics for the company are shown below: Shares of common stock outstanding = 1,000,000 Common stock price = $20 per share Expected level of EBIT = $5,000,000 Dividend payout ratio = 100 percent In answering the following questions, assume that corporate income is not taxed.
a) Under the present capital structure, what is the total value of the firm?
b) What is the cost of common equity capital, Kc? What is the composite cost of capital, K0?
c) Now suppose that Boston Textiles sells $1 million of long-term debt with an interest rate of 8 percent. The proceeds are used to retire outstanding common stock. According to NOI theory (the independence hypothesis), what will be the firm’s cost of common equity after the capital structure change?
1. What will be the dividend per share flowing to the firm’s common shareholders? 2. By what percent has the dividend per share changed owing to the capital structure change? 3. By what percent has the cost of common equity changed owing to the capital structure change? 4. What will be the composite cost of capital after the capital structure change?