Question
Ajax Corporation has the following financial position: Assets $600,000 EBIT $1,000,000 Cost of equity 10% Tax rate 35% Shares 200,000 Debt zero The firm has
Ajax Corporation has the following financial position:
Assets $600,000
EBIT $1,000,000
Cost of equity 10%
Tax rate 35%
Shares 200,000
Debt zero
The firm has decided to sell bonds and use the proceeds to buy its stocks. They sell enough bonds to buy half of their stocks at the prevailing price, which makes its capital structure 50% debt and 50% equity. Bonds can be sold at the rate of 8%, and due to increasing risk (because of debt), the stockholders will require 12% (instead of 10% before). Ajax is a no-growth company, and its earnings are expected to stay constant, and all earnings will be paid as dividends.
Find:
- The value of the firm and its stock price with no debt.
- The value of the firm and its stock price after the bond issue.
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