An all-equity firm is subject to a 30 per cent tax rate. Its total market value is initially $3,500,000. There are 175,000 shares outstanding. The firm announces a program to issue $1 million worth of bonds at 10 per cent interest and to use the proceeds to buy back common stock. Assume that there is no change in costs of financial distress and that the debt is perpetual.

1. What is the value of the tax shield that the firm acquires through the bond issue? (2 marks)
2. According to Modigliani & Miller, what is the likely increase in market value per share of the firm after the announcement, assuming efficient markets? How many shares can be repurchased for this market value per share? (9 marks)
3. What is the likely increase in market value per share of the firm if we do not assume efficient markets, and shareholders who sell their shares do not realize the gains available from the tax shield? (9 marks)