Answer:
Explanation:
Given that :
Current share price = $35
Share outstanding = 28,000, 000
Bond outstanding = 58,000
current bond price = 104 % par value
Default par value of the bond = $1000
Target Debt /Equity ratio = 1.3
The type of security (stocks or bonds) it would need to sell to accomplish this is as follows:
Total debt = current bond price × bonds outstanding
= 104% par value × 58000
= 104 % × 1000 × 58000
= $ 60,320,000
Total equity = current share price × shares outstanding
Total equity = 35 × 28,000,000
Total equity = $ 98,000,000
Current debt-equity ratio = Total debt/ total equity
= $ 60,320,000/ $ 98,000,000
= 0.62
Hence , the current debt ration is 0.62 which is less than the target 1.3. Thus, the company needs to issue debt bonds to buy-back shares to make changes in the capital structure in order to achieve the target capital structure of 1.3
How much to be sold to achieve the target capital structure of 1.3
Total Value = Debt + Equity
Total Value = 60,320,000 + 98,000,000
Total Value = 158,320,000
Current debt ratio = Debt/total value
Current debt ratio = 60,320,000/158,320,000
Current debt ratio = 0.381
Required debt ratio = Target dent ratio/1+ target debt ratio
Required debt ratio = 1.3/1+1.3
Required debt ratio = 1.3/2.3
Required debt ratio = 0.5652
Debt to be sold = (Target debt ratio - current debt ratio) × Total value
Debt to be sold = (0.5652 - 0.381) × 158,320,000
Debt to be sold = 0.1842 × 158,320,000
Debt to be sold = $29,162,544
Hence, the new debt to be sold is $29,162,544 to achieve target debt equity ratio of 1.3
Verify:
New debt = Old Debt +New debt sold
New debt = $60,320,000 + $29,162,544
New debt = $89,482,544
New Equity = Old Equity - New Equity (i.e new debt sol/buy back share)
New Equity = $98,000,000 - $29,162,544
New Equity = $68,837,456
New debt equity ratio = New debt/ New equity
New debt equity ratio = $89,482,544/ $68,837,456
New debt equity ratio = 1.299
New debt equity ratio ≅ 1.3 Target D/E ratio
Hopes that helps a lot!
