Green Manufacturing, Inc., plans to announce that it will issue $3 million of pe
ID: 2665327 • Letter: G
Question
Green Manufacturing, Inc., plans to announce that it will issue $3 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a 6 percent annual coupon rate. Green is currently an al-equity firm worth $9.5 Million with 600,000 shares of common stock outstanding. After the sale of bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.8 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tas rate of 40 percent.a. What is the expected return on Greens's equity before the announcement of the debt issue?
b. Construct Green's market value balance sheet before the announcement of the debt issue. What is the price per share of the firm's equity?
c. Construct Green's market value balance sheet immediately after the announcement of the debt issue.
d.What is Green's stock price per share immediately after the repurchase announcement?
e. How many shares will Green repurchase as a result of the debt issue? How many shares of common stock will remain after the repurchase?
f. Construct the market value balance sheet after the restructuring.
g. What is the required return on Green's equity after the restructuring?
Explanation / Answer
a. Expected Return = Pretax earning(1- tax)/Total equity
Expected Return = $1.8 million(1-.40)/$9.5 million = 11.37%
b.
Balance sheet
Assets
$9,500,000
Debt
$0
Equity
$9,500,000
Total
$9,500,000
Total
$9,500,000
Price per share = Equity/common shares = $9,500,000/600,000 = $15.83
c.
Balance sheet
Assets
$9,500,000
Debt
$0
PV of tax shield
$1,200,000
Equity
$10,700,000
Total
$10,700,000
Total
$10,700,000
PV of tax shield = $3,000,000(debt) * .40(tax) =$1,200,000
d.
Price per share = Equity/common shares = $10,700,000/600,000 = $17.83
e.
Shares = Total debt/price per share
= $3,000,000/$17.83 =168224 shares
common stock will remain after the purchase =600,000 - 168224 = 431,776
f.
Balance sheet
Assets
$9,500,000
Debt
$3,000,000
PV of tax shield
$1,200,000
Equity
$7,700,000
Total
$10,700,000
Total
$10,700,000
g.
Rs = Re + B/S (Re -Rb)(1-tax)
Rs = 11.37% + $3,000,000/$7,700,000 (11.37%-6%)(1-.40)= 12.63%
Balance sheet
Assets
$9,500,000
Debt
$0
Equity
$9,500,000
Total
$9,500,000
Total
$9,500,000
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