Firm R currently has $1,000,000 of debt outstanding with a before tax annual cou
ID: 2737546 • Letter: F
Question
Firm R currently has $1,000,000 of debt outstanding with a before tax annual coupon of 5%, a constant EBIT of $2,000,000 and 400,000 shares outstanding at a market price of $25.00. The firm is considering issuing $1,500,000 of debt at a before tax cost of 6.5% and using the proceeds to repurchase stock at the new post-announcement market price. If this plan is implemented, it is expected that the required return on equity would rise to 10%. The firm's marginal tax rate is 32%. What is the estimated value of the firm after the new debt issue? What is the estimated share price after the capital structure change? How many shares remain outstanding after the capital structure change?
Explanation / Answer
Company current market price is $25.00
Number of shares available = 400,000
Repurchase of stock ($1,500,000 /$25) = 60,000 shares
Remaining shares available (400,000 -60,000) = 340,000 shares
Market value of the firm (340,000 shares *$25) = $8,500,000
Capital structure of the company
Details
Amount
Debt outstanding (a)
$ 1,000,000
outstanding shares
400,000 *$25 (b)
$ 10,000,000
issue of new debt for repurchase of stock (c )
$ 1,500,000
Total debt (d) = (a) +(c )
$ 2,500,000
Total shares value (e)
$ 8,500,000
Total portfolio (d) + (e)
$ 11,000,000
Therefore, available shares of the company are 340,000 shares.
Details
Amount
Debt outstanding (a)
$ 1,000,000
outstanding shares
400,000 *$25 (b)
$ 10,000,000
issue of new debt for repurchase of stock (c )
$ 1,500,000
Total debt (d) = (a) +(c )
$ 2,500,000
Total shares value (e)
$ 8,500,000
Total portfolio (d) + (e)
$ 11,000,000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.