Tax-exempt all equity firm with 10,000 shares outstanding EBIT= 175000 Sharehold

Question

Tax-exempt all equity firm with 10,000 shares outstanding

EBIT= 175000

Shareholders required rate of return=15%

You're considering buying 1000 shares of the firm

1. Value of firm?

2. Price per share?

3. How much will need to be invested in the firm?

If an income tax of 35% is introduced:

4. New value of the firm and price per share?

5. Value of your shares if the company issues $50,000 of repurchase shares and bonds?

6. Why do shareholders prefer projects with high risk when a company's capital structure includes debt?

Explanation / Answer

1. Value of firm = 175000/0.15 = 1166666.67

2. Price per share = 1166666.67/10000 = 116.67

3. Amount to be invested = 1000 Shares* 116.67 = $ 116667

4)

EBIT after tax = 175000 *(1-0.35) = 113750

Value of firm = 113750/0.15 = 758333

Price per share = 758333 / 10000 = $75.83

5)

value of shares = 75.83 *1000 = 75833

6) Shareholders prefer projects with high risk when a company's capital structure includes debtbecause they yield high returns and high reward.

Thanks

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