g Inc., plans to announce that it will issue $1.8 million of at 6% and use the p
ID: 2796630 • Letter: G
Question
g Inc., plans to announce that it will issue $1.8 million of at 6% and use the proceeds to repurchase common stock. Stock Value and Leverage Green perpetual debt (the principal is never repaid) Gireen is currently an all-equity company worth $5.9 million with 350,000 shares of common stock outstanding. After the sale of the bonds, the company will maintain the new capital structure indefinitely. Ihe company currently generates annual pretax earnings (i.e, EBIT) of $1.35 million. This level of earnings 4. is expected to remain constant in perpetuity. The tax rate is 40 percent a. How much annual income do all of the security holders (stock & bond holders combined) receive if Green: I. remains equity financed (U) 2. becomes recapitalized (L) EBIT 350,000-o 1350, 000- 108,000 Interest EBT - Tax NI +Interest Income to ALL 810,000 0 s200 + 108,000 810000 gS3,a00 b. What is the expected return on the company's equity before the announcement of the debt issue? In other words, what is the Green's all-equity cost of capital (WACCuor Ro)? [Hintj: "all-equity company worth $5.9 million" means Vu $5.9 million, think about the formula for Vu and extract R Regardless of what you got in part a, use 13.73% to find the market value of Green's as an all-equity financed company c. Show its current capital structure: Debt 1,800,oco Value 5,900,obo Equity ,100,0c0 EBIT (1-Tc) 13. 73% d. Using M&M; with taxes and no bankruptcy risk, what is the present value of the interest tax shield for Green? .40135002140,000Explanation / Answer
Unlevered Levered a) EBIT 1350000 1350000 Interest 0 108000 EBT 1350000 1242000 Tax at 40% 540000 496800 NI 810000 745200 Interest 0 108000 Income to all 810000 853200 b) Cost of equity = WACC = 810000/5900000 = 13.73% c) Capital structure: Debt 0 Equity 5900000 Total 5900000 d) PV of interest tax shield = Debt*tax rate = = 1800000*40% = 720000 e) Value of levered firm = Value of unlevered firm + PV of Tax shield on interest Since the debt perpetual, the above equation becomes Value of levered firm = Value of unlevered firm + Borrowing*tax rate = $5,900,000+$1,800,000*40% = $6,620,000 The total capital will be $6,620,000 and the value of equity will also be $6,620,000, as the debt is not issued. f) Price per share = 6620000/350000 = $ 18.91 g) 1) Shares it will buy back = 1800000/18.91 = 95188 2) Shares outstanding = 350000-95188 = 254812 3) Price per share after recapitalization = (6620000-1800000)/254812 = $ 18.92 h) Unlevered Levered EBIT 1350000 1350000 Interest 0 108000 EBT 1350000 1242000 Tax at 40% 540000 496800 NI 810000 745200 Number of shares 350000 254812 EPS $ 2.31 $ 2.92 Price $ 18.91 $ 18.91 P/E 8.17 6.47
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