Green Manufacturing, Inc., plans to announce that it will issue $2.06 million of

Question

Green Manufacturing, Inc., plans to announce that it will issue $2.06 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity firm worth $7.38 million with 460,000 shares of common stock outstanding. After the sale of the bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.56 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 40 percent. What is the required return on Green’s equity after the restructuring?

Explanation / Answer

Present worth $7,380,000.00 Common stocks Outstanding $460,000.00 Price /stock $16.04 Current EBIT $1,560,000.00 Tax rate   40% Post Tax income $936,000.00 Assume expected return on equity before repurchase=k 936000/k=7380000 k=   12.68% So Expected return on Green's Equity= 12.68% Required return after repurchase Debt Value $2,060,000.00 Equity value after repurchase= $5,320,000.00 Debt Equity ratio = D/E 0.39 Cost of debt = Kd 6% Tax rate =T 40% Cost of unlevered equity = Ku 12.68% Cost of levered Equity= Ku+(1-T)*D/E*(Ku-Kd) 0.1424 Cost of equity after repurchase 14.24%

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.