3.

Question (10 marks)

Newland is currently an all-equity firm with expected annual earnings before taxes of $9 million in perpetuity. The current required return on the firms equity is 12 percent and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.2 million shares of common stock outstanding and is subject to a corporate tax rate of 30 percent. The firm is planning a recapitalization under which it will issue $15 million of perpetual 6 percent debt and use the proceeds to buy back shares.

Required:

(a) Calculate the value of the company before the recapitalization plan is announced. (3 marks)

(b) Use the APV method to calculate the company value and share price immediately after the recapitalization plan is announced. (7 marks)