Twin City Printing Is Considering Two Financial Alternatives for Financing

question 49

Multiple Choice

Twin City Printing is considering two financial alternatives for financing a major expansion program. Under either alternative EBIT is expected to be $15.6 million. Currently the firm's capital structure consists of 4 million shares of common stock and $35 million in 11% long-term bonds. Under the debt financing alternative $10 million in 12% long-term bonds will be sold, and under the equity financing alternative the firm would sell 500,000 shares of common stock. The P/E under the debt alternative would be 15, and the P/E under the equity alternative would be 16. The firm's marginal tax rate is 40%. Which alternative would produce the higher stock price?

• A) debt-stock price of $23.70
• B) debt-stock price of $32.29
• C) equity-stock price of $25.12
• D) equity-stock price of $33.28

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Definitions:

Expected Excess Return

The return on an investment over the risk-free rate of return that is anticipated based on risk assessment.

Beta Coefficient

A measure of a stock's volatility in relation to the overall market; a beta greater than 1 indicates more volatility than the market.

One-Factor APT

A model that describes financial markets and attempts to predict the returns of securities with a single factor, usually related to economic risk.

Standard Deviation

A measure of the dispersion of a set of data from its mean, indicating volatility.