(The Following Data Apply to Problems 63, 64, and 65

question 14

Multiple Choice

(The following data apply to Problems 63, 64, and 65. The problems MUST be kept together.)
Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the market value capital structure indicated below. The money raised would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.
EBIT = $80,000 New Debt/Value = 20%
Growth = 0% New Equity/Value = 80%
Orig cost of equity, rs = 10.0% No. of shares = 10,000
New cost of equity = rs = 11.0% Price per share = $48.00
Tax rate = 40% Interest rate = rd = 7.0%
-Now assume that VF is considering changing from its original zero debt capital structure to a new capital structure with even more debt. This results in changes in the cost of debt and equity, and thus to a new WACC and a new value of operations. Assume VF raises the amount of new debt indicated below and uses the funds to purchase and hold T-bills until it makes the stock repurchase. What is the stock price per share immediately after issuing the debt but prior to the repurchase? Debt/Value = 40% Value of new debt = $213,333
Equity/Value= 60% New WACC = 9.0%

• A) $50.67
• B) $53.33
• C) $56.00
• D) $58.80
• E) $61.74

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Definitions:

Conservatism

A political and social philosophy promoting traditional institutions and practices, emphasizing stability, and often resisting rapid changes in society.

Self-Transcendence

A trait dealing with the expansion of personal boundaries, including experiencing spiritual aspects and unifying with other people and the world.

Self-Enhancement

The motivation or tendency to view oneself favorably and to seek positive feedback, often by emphasizing one’s strengths and minimizing weaknesses.

Deconstructionism

A philosophy that argues reality does not exist apart from human perceptions, or constructions, of it.