All equity business has 100 million shares outstanding selling for $20 a share.

Question

All equity business has 100 million shares outstanding selling for $20 a share. Management believes interest rates are unreasonably low and decides to execute a leverages recapitalization. It will raise $1 billion in debt and repurchase 50 million shares.

A. What is the market value of the firm prior to the recap?

What is the market value of equity?

B. Assuming the Irrelevance Porposition holds, what is the market value oft he firm after the recap?

What is the market value of equity?

C. Do equity shareholders appear to have gained or lost as a result of the recap? Explain.

D. Assume now that the recap increases total firm cash flows, which adds $100 million to the value of he firm. Now what is the market value of the firm?

What is the market value of equity?

E. Do equity shareholders appear to have gained or lost as a result of the recap in this revised scenario?

Explanation / Answer

AnswerS:

A) MArket VAlue of Firm Prior to recap = $100 *20= 2000 Million

Market Value of Equity = $2000 Million

B) MArket VAlue of Firm = 1000 Million + 20*50 = 2000 Million

Value of Equity = 20*50 = 1000 Million

C) Equity shareholders have lost because of recap they lose their entire right of profits by arising of interest factor.

D) MArket VAlue = 2000+100 = 2100 Million

Market value of Equity = 1100 Million

E) equity shareholders gain now because of increase in the cash flows

tHanks

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