Green Manufacturing, Inc., plans to announce that it will issue $1.99 million of
ID: 2497061 • Letter: G
Question
Green Manufacturing, Inc., plans to announce that it will issue $1.99 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 5 percent. Green is currently an all-equity firm worth $6.12 million with 390,000 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 $1.49 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 35 percent.
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))
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))
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))
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))
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))
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))
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))
Explanation / Answer
a)Expected return on equity=Annual pre tax earning*(1-tax rate)/Market value of company
=1.49*(1-0.35)/6.12=15.83%
b)Market price per share= Market value/no of shares= 6.12*10^6/390,000=$15.69
d)After Repurchase announcement the equity
Equity+Present value of tax shield=6.12*10^6+(35%of 1.99*10^6)
=$6.82mn
price per share=6.82*10^6/390,000
=$17.48
e)no of shares=1.99mn/17.48=113,856
e2)remaining=390,000-113,856=276,144
g)Rs=R0+(B/S)(R0-Rb)*(1-t)
R0=15.83% B=1.99mn S=4.83mn Rb=5%t=35%
=15.83%+(1.99/4.83)*10.83%*0.65
=18.73%
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