1300 Smiles Limited (ONT) owns and operates full-service dental facilities at its sites in New South Wales, South Australia, and in the ten major population centres in Queensland and also in Adelaide. 1300SMILES enables the delivery of services to patients by providing the use of dental surgeries, practice management and other services to self-employed dentists who carry on their own dental practices.

ONTs market capitalisation currently runs at about $152 million, with a debt-to-equity ratio of approximately 1:38 or 58/42. The companys CFO is currently recommending that the Board issue new debt worth 10% of the firms existing debt to repurchase shares for the same amount. He is advocating for a recapitalisation of the firms balance sheet in order to realise an increase in firm value by having a higher debt level. The debt issue will take the form of a 10-year corporate bond with a yearly coupon equal to the firms current cost of debt of 4.3%.

ONTs CFO has approached Access Economics for assistance in formulating a solid argument for the proposed increase in financial leverage. While there is a tax advantage associated with debt financing, the team at Access Economics are concerned with the more subtle considerations about personal taxes at the investor level that also need to be taken into account. The consulting team will therefore consider three different tax settings:

A world with no taxes

A world with corporate taxes only

A world with taxes paid on all levels

ONTs marginal corporate tax rate is 30%. Assume that the marginal personal tax rate on income from debt is 35% and that the marginal personal tax rate on income from equity is 28%.

Determine the new share price and number of shares outstanding in each of the three tax settings.

a. Assume that the current market value of ONTs equity is based on a current share price of $7.13 and total shares outstanding of 21,300,000.

b. Determine the new market value of equity if the share repurchase occurs.

c. Determine the share price at which shareholders are willing to sell their shares given the information about the new debt. Note: Format the share price with three or four decimals, as the differences in share price might be less than one cent.

d. Determine the number of shares outstanding after the repurchase.