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Case 7 - An Introduction To Debt Policy and Value

The document compares the balance sheet of a company before and after recapitalization through additional debt. It shows that after taking on $1.565M in additional long-term debt and issuing no new shares, the total assets increase from $813,899 to $2,379,585. The market value of assets also increases from $1,889,153 to $3,987,172 due to a larger tax shield from higher debt. As a result of the recapitalization, the value per existing common share increases from $60.50 to $79.43 in the book value balance sheet and from $60.50 to $135.09 in the market value balance sheet.

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Anthony Kwo
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2K views

Case 7 - An Introduction To Debt Policy and Value

The document compares the balance sheet of a company before and after recapitalization through additional debt. It shows that after taking on $1.565M in additional long-term debt and issuing no new shares, the total assets increase from $813,899 to $2,379,585. The market value of assets also increases from $1,889,153 to $3,987,172 due to a larger tax shield from higher debt. As a result of the recapitalization, the value per existing common share increases from $60.50 to $79.43 in the book value balance sheet and from $60.50 to $135.09 in the market value balance sheet.

Uploaded by

Anthony Kwo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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Problem 1: Value of Assets

0% Debt/ 25% Debt/ 50% Debt/


100% Equity 75% Equity 50% Equity
Book Value of Debt - $ 2,500.00 $ 5,000.00
Book Value of Equity $10,000.00 $ 7,500.00 $ 5,000.00

Market Value of Debt - $ 2,500.00 $ 5,000.00


Market Value of Equity $10,000.00 $ 8,350.00 $ 6,700.00

Pretax Cost of Debt 0.07 0.07 0.07

After-Tax Cost of Debt 0.0462 0.0462 0.0462

Market Value Weights of


Debt 0% 23.04% 42.74%
Equity 100% 76.96% 57.26%
Unlevered Beta 0.80 0.80 0.80
Levered Beta 0.80 0.96 1.19
Risk-Free Rate 0.07 0.07 0.07
Market Premium 0.086 0.086 0.086
Cost of Equity 0.14 0.15 0.17
Cost of Debt 0.05 0.05 0.05
Weighted-Average Cost of Capital 0.14 0.13 0.12
EBIT $ 2,103.00 $ 2,103.00 $ 2,103.00
Taxes (@ 34%) $ 715.02 $ 715.02 $ 715.02
EBIAT $ 1,387.98 $ 1,387.98 $ 1,387.98
+ Depreciation $ 500.00 $ 500.00 $ 500.00
- Capital exp. $ (500.00) $ (500.00) $ (500.00)
+ Change in net working capital - - -
Free Cash Flow $ 1,387.98 $ 1,387.98 $ 1,387.98

Value of Assets (FCF/WACC) $ 9,999.86 $10,849.84 $11,699.83


Problem 2: Value of Equity and Debt

0% Debt/ 25% Debt/ 50% Debt/


100% Equity 75% Equity 50% Equity

Cash flow to creditors:


Interest $ - $ 175.00 $ 350.00
Pretax cost of debt 0.07 0.07 0.07
Value of debt: (CF/rd) $ - $ 2,500.00 $ 5,000.00

Cash flow to shareholders:


EBIT $ 2,103.00 $ 2,103.00 $ 2,103.00
- Interest - $175 $350
Pretax profit $ 2,103.00 $ 1,928.00 $ 1,753.00
Taxes (@ 34%) $ 715.02 $ 655.52 $ 596.02
Net income $ 1,387.98 $ 1,272.48 $ 1,156.98
+ Depreciation $ 500.00 $ 500.00 $ 500.00
- Capital exp. $ (500.00) $ (500.00) $ (500.00)
+ Change in net working capital - - -
- Debt amortization - - -
Residual cash flow $ 1,387.98 $ 1,272.48 $ 1,156.98

Cost of equity 0.14 0.15 0.17

Value of equity (CF/re) $ 9,999.86 $ 8,349.87 $ 6,699.88

Value of equity plus value of debt $ 9,999.86 $10,849.87 $11,699.88


Problem 3: Business Flows and Financing Effects

0% Debt/ 25% Debt/ 50% Debt/


100% Equity 75% Equity 50% Equity

Pure Business Cash Flows:


EBIT $ 2,103 $ 2,103 $ 2,103
Taxes (@ 34%) $ (715) $ (715) $ (715)
EBIAT $ 1,388 $ 1,388 $ 1,388
+ Depreciation $ 500 $ 500 $ 500
- Capital exp. $ (500) $ (500) $ (500)
+ Change in net working capital $ - $ - $ -
Cash Flow $ 1,388 $ 1,388 $ 1,388

Unlevered Beta 0.8 0.8 0.8


Risk-Free Rate 0.07 0.07 0.07
Market Premium 0.086 0.086 0.086
Unlevered WACC 13.88% 13.88% 13.88%

Value of Pure Business Flows:


(FCF/Unlevered WACC) $ 9,999.86 $ 9,999.86 $ 9,999.86

Financing Cash Flows


Interest $ - $ 175.00 $ 350.00
Tax Reduction $ - $ 59.50 $ 119.00

Pretax Cost of Debt 0.07 0.07 0.07

Value of Financing Effect:


(Tax Reduction/Pretax Cost of Debt) $ - $ 850.00 $ 1,700.00

Total Value (Sum of Values of


Pure Business Flows and Financing Effects $ 9,999.86 $10,849.86 $11,699.86
0% Debt/ 25% Debt/ 50% Debt/
100% Equity 75% Equity 50% Equity

Value of Asset $ 9,999.86 $ 10,849.86 $ 11,699.86


Cash Paid Out $ - $ 2,500.00 $ 5,000.00
Total Market Value of Equity $ 9,999.86 $ 8,349.86 $ 6,699.86
Number of Original Shares 1,000 1,000 1,000
Total Value Per Share $ 10.00 $ 10.85 $ 11.70
Exhibit 1
Koppers Company, Inc.

Before After
Recapitalization Recapitalization

Book Value Balance Sheets


Net working capital $ 212,453.00 $ 1,778,139.00
Fixed assets $ 601,446.00 $ 601,446.00
Total assets $ 813,899.00 $ 2,379,585.00

Additional debt $ 1,565,686.00


Long-term debt $ 172,409.00 $ 1,738,095.00
Deferred taxes, etc. $ 195,616.00 $ 195,616.00
Preferred stock $ 15,000.00 $ 15,000.00
Common equity $ 430,874.00 $ 430,874.00
Total capital $ 813,899.00 $ 2,379,585.00

Market-Value Balance Sheets


Net working capital $ 212,453.00 $ 1,778,139.00
Fixed assets $ 1,618,081.00 $ 1,618,081.00
PV debt tax shield $ 58,619.00 $ 590,952.30
Total assets $ 1,889,153.00 $ 3,987,172.30

Long term debt $ 172,409.00 $ 1,738,095.00


Deferred taxes, etc. $ - $ -
Preferred stock $ 15,000.00 $ 15,000.00
Common equity $ 1,701,744.00 $ 2,234,077.30
Total capital $ 1,889,153.00 $ 3,987,172.30

Number of shares $ 28,128.00 $ 28,128.00


Price per share $ 60.50 $ 79.43

Value to Public Shareholders


Cash received $ - $ 1,565,686.00
Value of shares $ 1,701,744.00 $ 2,234,077.30
Total $ 1,701,744.00 $ 3,799,763.30
Total per share $ 60.50 $ 135.09

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