Anson Jackson Court Company (AJC)

question 14

Multiple Choice

Anson Jackson Court Company (AJC)
The Anson Jackson Court (AJC) currently has $150,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6%.Its earnings before interest and taxes (EBIT) are $89,000, and it is a zero growth company.AJC's current cost of equity is 10%, and its tax rate is 25%.The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00.
-Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense.The company would issue new bonds and use the proceeds to buy back shares of its common stock.The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS) .Assuming the CFO's estimates are correct, which of the following statements is CORRECT?

• A) If the plan reduces the WACC, the stock price is also likely to decline.
• B) Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
• C) If the plan does increase the EPS, the stock price will automatically increase at the same rate.
• D) Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
• E) Since the proposed plan increases Daylight's financial risk, the company's stock price still might fall even if EPS increases.

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Definitions:

Probability of Failure

The likelihood or risk that a system, component, or process will fail to perform within an expected timeframe.

Payoff Matrix

A table that shows the potential outcomes or payoffs of different strategies in a game or competitive situation.

Christmas Gifts

Items purchased or made to be given to others during the Christmas holiday as a gesture of goodwill and celebration.

Best Interest

A principle that emphasizes acting with the utmost benefit or advantage to a specific party, especially in fiduciary duties.