An all-equity firm is subject to a 30% tax rate. Its total market value is initi

Question

An all-equity firm is subject to a 30% tax rate. Its total market value is initially $3,500,000, and there and 175,000 shares outstanding. The firm announces a program to issue $1 million worth of bonds at 10% interest and to use the proceeds to buy back common stock.

a. What is the value of the tax shield that the firm acquires through the bond issue?

b. According to M&M, what is the likely increase in market value per share of the firm after the announcement (assuming efficient markets)?

c. How many shares will the company be able to repurchase?

Explanation / Answer

1. the value of the tax shield that the firm acquires through the bond issue is 27%

2. likely increase in market value per share of the firm after the announcement (assuming efficient markets) is $28

3. 50000 shares comapny be able to purchase.

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