Pelabur’s Pizza Mini Case †Capital Structure Decision

a) Repurchase of stock=RM15x100000shares=RM1500000 Equity after repurchase of stock=repurchase of stock-amount borrowed Scenario |Amount borrowed(RM) |Equity after repurchase of stock(RM) | |1 |0 |1500000-0=1500000 | |2 |187500 |1500000-187500=1312500 | |3 |375000 |1125000 | |4 |562500 |937500 | |5 |750000 |750000 | |6 |937500 |562500 | |7 |1125000 |375000 | b) Weight of equity=(equity after repurchase of stock/repurchase of stock) x100% Weight of debt + weight of equity=100% |Scenario |Weight of debt(%) |Weight of equity(%) | |1 |100-100=0 |1500000/1500000 x100%=100. | |2 |100-87. 5=12. 5 |1312500/1500000 x100%=87. 5 | |3 |25. 0 |75. 0 | |4 |37. 5 |62. 5 | |5 |50. 0 |50. 0 | |6 |62. 5 |37. 5 | |7 |75. 0 |25. | c) After-tax cost of debt=pre-tax cost of debt x (1-T) =(prime rate + risk premium)x(1-T) |Scenario |Prime rate(%) |Risk premium(%) |Tax(%) |After-tax cost of debt(%) | |1 |5 |2. 0 |40 |(5%+2%)x(1-0. 4)=4. 2 | |2 |5 |2. 0 |40 |(5%+2%)x(1-0. 4)=4. 2 | |3 |5 |2. 5 |40 |4. | |4 |5 |3. 5 |40 |5. 1 | |5 |5 |5. 0 |40 |6. 0 | |6 |5 |7. 0 |40 |7. 2 | |7 |5 |10. 0 |40 |9. 0 | d) CAPM=Krf+(RPm)? , Krf=4% , RPm=8% |Scenario |Subjective beta, ? CAPM(%) | |1 |2. 0 |4%+8%(2. 0)=20. 0 | |2 |2. 1 |4%+8%(2. 1)=20. 8 | |3 |2. 3 |22. 4 | |4 |2. 5 |24. 0 | |5 |2. 9 |27. 2 | |6 |3. 3 |30. 4 | |7 |3. 7 |33. | e) WACC=WdKd+WsKs |Scenario |Wd(%) |Ws(%) |Kd(%) |Ks(%) |WACC(%) | |1 |0 |100. 0 |4. 2 |20. 0 |0(0. 042)+1(0. 2)=20. 00 | |2 |12. 5 |87. 5 |4. 2 |20. 8 |0. 125(0. 042)+0. 875(0. 208)=18. 73 | |3 |25. 0 |75. 0 |4. 5 |22. 4 |17. 93 | |4 |37. 5 |62. 5 |5. 1 |24. |16. 91 | |5 |50. 0 |50. 0 |6. 0 |27. 2 |16. 60 | |6 |62. 5 |37. 5 |7. 2 |30. 4 |15. 90 | |7 |75. 0 |25. 0 |9. 0 |33. 6 |15. 15 | f) Shares repurchased=amount borrowed/repurchased stock price per share Remaining shares outstanding=shares outstanding (old)-shares repurchased Scenario |Shares outstanding |Shares repurchased |Remaining shares outstanding | |1 |100000 |RM0/RM15=0 |100000-0=100000 | |2 |100000 |RM187500/RM15=12500 |100000-12500=87500 | |3 |100000 |25000 |75000 | |4 |100000 |37500 |62500 | |5 |100000 |50000 |50000 | |6 |100000 |62500 |37500 | |7 |100000 |75000 |25000 | g) Total asset=Earning(net income)/WACC otal equity=total assets-total liabilities Interest expense=amount borrowed x interest rate(prime rate + risk premium) |Scenario |1 | |1 |300000/100000=3. 00 | |2 |292125/87500=3. 34 | |3 |3. 78 | |4 |4. 34 | |5 |5. 0 | |6 |6. 20 | |7 |7. 95 | h) There are two main types of financing for a business which are debt or equity financing. Debt financing is describe as the type of financing we receive from a traditional bank loan and equity financing is describes as the financing we receive from venture capital into our business from outside investors.Therefore, the benefit of debt financing is refer to it’s limited in amount and we will pay down the debt over time to a zero sum balance without any further obligation to the lender and the down stroke to debt fin ancing is to define that traditional lenders will take a hard look at our business including how long it has been in existence, income from operation, expenses and it will require hard assets for collateral for the loan. Moreover, those lenders will most certainly want us to personally guarantee for the repayments of the loan. Another disadvantage of debt financing is that our organization will be burdened with some other type of regular payment which is usually a monthly payment which depending on the terms and conditions of the financing and this can absorbs critical cash flow, especially those individual or partners with small business.Besides that, the benefit of equity financing or venture capital is that we will be also receiving money in exchange for equity in our business in the form of stock or some other form of equity like percentage of income or gross net sales. A fundamental benefit of this type of the equity financing is to define there is no monthly payment requiremen t to investors. Instead, we are giving up ownership interest, most often, permanently. Furthermore, the traditional lenders, banks for example, will look at our business much slightly different than venture capitalist. Bankers want a zero-risk or near-zero risk position when they provide financing and will rely almost completely on the operating economics of the business with little regard for potential future growth.Thus, they want to see strong cash flow backed up by hard assets before they do a deal with the ingredients that most small business lack or they wouldn’t be seeking for financing. Eventually, the venture capitalist is on the other hand which they tend to consider the management team and the potential future growth of the business more heavily than actual operating numbers, especially for those with small business with large potential but few sales and little or no operating history. Although these two types of lender is vary in their approaching to analyzing a b usiness for funding, we can also be sure that careful examination of our business will be conducted.