Warsaw Manufacturing, Inc., plans to announce that it will issue $1.9 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 5 percent. The company is currently all-equity and worth $6.7 million with 290,000 shares of common stock outstanding. After the sale of the bonds, the company will maintain the new capital structure indefinitely. The annual pretax earnings of $1.32 million are expected to remain constant in perpetuity. The tax rate is 21 percent.
a. What is the expected return on the company’s equity before the announcement of the debt issue?
b. Construct the company’s market value balance sheet before the announcement of the debt issue. What is the price per share of the firm’s equity?
c. Construct the company’s market value balance sheet immediately after the announcement of the debt issue.
d. What is the company’s stock price per share immediately after the repurchase announcement?
e. How many shares will the company repurchase as a result of the debt issue? How many shares of common stock will remain after the repurchase?
f. Construct the market value balance sheet after the restructuring.
g. What is the required return on the company’s equity after the restructuring?