The Hifalutin Co

question 17

Multiple Choice

The Hifalutin Co. has perpetual EBIT of $3,000. It has no debt in its capital structure, and its cost of equity is 15%. The corporate tax rate is 40%. There are 300 shares outstanding. Hifalutin has announced that it will borrow $3,750 in perpetual debt at 8% and use the proceeds to buy up stock. A firm is all equity with 5,000 shares outstanding worth $7 each. They are planning on issuing $10,000 of new perpetual debt at the 8% market rate of interest. The effective tax rate is 25%. What is the change in equity value if they make the debt for equity exchange?

• A) $.50 per share
• B) $200
• C) $800
• D) $.16 per share

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Definitions:

Raw Materials Used

The total value of all raw materials employed in the manufacturing process to produce finished goods during a specific accounting period.

Manufacturing Overhead

All manufacturing costs that are not directly involved in the production of a product, including indirect materials, indirect labor, and other indirect costs.

Credit Balance

The amount of money that a company or individual has in their account, indicating that they have received more money than they have spent.

Overapplied

A situation where the allocated overhead costs for a product or service exceed the actual overhead costs incurred.