Capital Structure (with taxes): Hint: read section 18.3 in your textbook (from page 626 to the top ofpage 629) before attempting this question. Gem Industries has 5 million shares outstanding with a market price of $69 per share and no debt. Gem Industries has had consistently stable earnings and pays a 30% corporate tax rate. Although investors expect Gem to remain all-equity financed, management plans to announce that Gem will borrow $150 million on a permanent basis (after borrowing the $150 million, Gem's debt is not expected to change). They would use the borrowed funds to repurchase some of their outstanding shares. Their expectation is that levering up will boost Gem Industries' share price. Note: use Modigliani and Miller's theory of capital structure with corporate taxes and permanent debt when answering questions a, b and c below. a. What is Gem Industries' firm value before the announcement? b. What is Gem Industries' firm value and share price immediately after the announcement (before the debt 3. is issued)? (Think about the implications of the Efficient Market Hypothesis.) How many shares will Gem Industries repurchase? How many will remain outstanding and what is the market value of Gem Industries' equity (the value of all Gem Industries shares combined) after the share repurchase is completed? Besides corporate taxes, what other factors will influence Gem's firm value as a result of the increase in leverage? Use the trade-off theory of capital structure to examine the impact of the change in Gem's capital structure. (No calculations are required.) c. d. Helpful formulas: Vu-Number of Shares Share Price (value of unlevered firm = mkt value of equity) and VL = Vu + D Tc