Currently, the firm is all equity funded with 500000 shares valued at $10 per sh

Question

Currently, the firm is all equity funded with 500000 shares valued at $10 per share and the required return on equity is 15.6%. Income tax rate is 40%. Your banker has indicated that the following leverage restructurings are possible:

Debt Leverage 10.00% 20.00% 30.00%

Interest 8.50% 9.00% 9.50%

ROE 16.00% 17.00% 19.00%

1. Estimate the share prices for the following debt restructures 10%, 20%, and, 30%, respectively:

A $10.44; $10.68; $10.48

B $10.68; $10.48; $10.44

C $10.68; $10.44; $10.48

D $10.48; $10.68; $10.44

E $10.44; $10.48; $10.68

2. Estimate which two debt restructures maximize firm value.

A 0%; 10%

B 20%; 30%

C 30%; 0%

D 10%; 20%

E 0%; 20%

Explanation / Answer

Question.1

The price of the shares should increase as debt increases since value of the company increases with debt.

So, Answer is E: 10.44,10.48 adn 10.68 (Since that is only increasing trend)

Question 2:

Highest debt value maximizes the firm value , So answer is B: 20%; 30%

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