Please note thefollowing:
-Ensure that you submit all the required documents:1-the report in Word format;and 2- the formulated Excel sheet with yourcalculations.
- Referenceyour answers when and if needed.
Camper Design, Inc. Report Assume that you have just been hired as business manager of Camper Design (CD). Sales were $1,100,000 last year, variable costs were 60% of sales, and fixed costs were $40,000. Therefore, EBIT totaled $400,000. Because of economic conditiond, EBIT is expected to be constant over time. Because no expansion capital is required, CD pays out all earnings as dividends. Assets are $2 million, and 80,000 shares are outstanding. The management group owns about 50% of the stock, which is traded in the over-the-counter market. CD currently has no debt—it is an all-equity firm—and its 80,000 shares outstanding sell at a price of $25 per share, which is also the book value. The firm’s federal-plus-state tax rate is 40%. You believe that CD’s shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion. In today’s market, the risk-free rate, rRF, is 6% and the market risk premium, RPM, is 6%. CD’s unlevered beta, bU, is 1.0. Since CD currently has no debt, its cost of equity (and WACC) is 12%. If the firm restructures its debt and equity ratio i.e. recapitalizes, then debt would be issued and the borrowed funds would be used to repurchase stock. You plan to complete your report by asking and then answering the following questions. 1. What is business risk? What factors influence a firm’s business risk? 2. What is operating leverage, and how does it affect a firm’s business risk? 3. What do the terms financial leverage and financial risk mean? 4. How does financial risk differ from business risk? 5. To develop an example that can be presented to CD’s management as an illustration, consider two hypothetical firms: Firm U with zero debt financing and Firm L with $10,000 of 12% debt. Both firms have $20,000 in total assets and a 40% federal-plus-state tax rate, and they have the following EBIT probability distribution for next year: Probability EBIT 0.25 $2,000 0.5 3,000 0.25 4,000 Complete the partial income statements for “Firm L” and “Firm U” below in an Excel Spreadsheet and submit it along with the Word document containing the report. Include a screen shot of the income statements in your Word document. 6. After speaking with a local investment banker, you obtain the following estimates of the cost of debt at different debt levels (in thousands of dollars). Now consider the optimal capital structure for CD and define the terms optimal capital structure and target capital structure. Amount D / Capital D / E Bond Borrowed Ratio Ratio Rating rd $0 0.0000 0.0000 -- -- $250,000 0.1250 0.1429 AA 8.0% $500,000 0.2500 0.3333 A 9.0% $750,000 0.3750 0.6000 BBB 11.5% $1,000,000 0.5000 1.0000 BB 14.0% 7. Why does CD’s bond rating and cost of debt depend on the amount of money borrowed? 8. Assume that shares could be repurchased at the current market price of $25 per share. Calculate CD’s expected EPS at debt levels of $0, $250,000, $500,000, $750,000, and $1,000,000. How many shares would remain after recapitalization under each scenario? 9 what is the cost of equity if CD recapitalizes with $250,000 of debt? $500,000? $750,000? $1,000,000? 10. Considering only the levels of debt discussed, what is the capital structure that minimizes CD’s WACC? 11. What would be the new stock price if CD recapitalizes with $250,000 of debt? $500,000? $750,000? $1,000,000? Remember that the dividend payout ratio is 100%. 12. Is EPS maximized at the debt level that maximizes share price? Why or why not? 13. Considering only the levels of debt discussed, what is CD’s optimal capital structure? 14. What is the WACC at the optimal capital structure? TOTAL CAPITAL EQUITY PROBABILITY SALES OPER. COSTS EBIT INTEREST EXPENSE EBT TAXES (40%) NET INCOME ROE Expected (ROE) FIRM U FIRM L 15. Suppose you discovered that CD had more business risk than you originally estimated. Describe how this would affect the analysis. How would the analysis be affected if the firm had less business risk than originally estimated? 16. What are some factors a manager should consider when establishing his or her firm’s target capital structure? 17. How does the existence of asymmetric information and signaling affect capital structure?