Green Manufacturing, Inc., plans to announce that it will issue $1.92 million of

Question

Green Manufacturing, Inc., plans to announce that it will issue $1.92 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity firm worth $4.91 million with 320,000 shares of common stock outstanding. After the sale of the bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.42 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 40 percent.

A. What is the expected return on Green’s equity before the announcement of the debt issue? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)

B. What is the price per share of the firm’s equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)

C. What is Green’s stock price per share immediately after the repurchase announcement? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)

D. How many shares will Green repurchase as a result of the debt issue? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

E. How many shares of common stock will remain after the repurchase? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)

F. What is the required return on Green’s equity after the restructuring? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Ans. Amount in mn
Equity Share Capital                                           4.91
Nos. of Equity Share Capital                                    320,000
Amount of debt to be issued                                           1.92
Interest Rate on debt 6%
Pretax Earning                                           1.42
Tax rate 40%
Post Tax Earning                                           0.85

(a) Expected return on equity before debt issue                                         17.35

(b) Price per share of the firm’s equity                                         15.34

(C ) Price per share of the firm’s equity after repurchase:
Equity after re-purchase                                           2.99
Equity share capital to be re-purchase                              125,132.38
Nos. of Equity Share Capital after re-purchase                              194,867.62
Price per share after repurchase                                         15.34

(d) shares will Green repurchase as a result of the debt issue                              125,132.38

(e) shares of common stock will remain after the repurchase                              194,867.62

(f) Interest to be paid on debt                                           0.12
Pretax Earning after interest on debt                                           1.30
Post Tax Earning                                           0.78
Amount of Equity share capital                                           2.99
Return on equity                                         26.18

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