Question
Executive LUCY is financed solely by common stock and has 20 million shares outstanding with a market price of 10 a share. Executive LUCY has
Executive LUCY is financed solely by common stock and has 20 million shares outstanding with a market price of 10 a share. Executive LUCY has estimated the expected rate of return to equity holders at 10%. It now announces a plan to issue 120 million of debt at an interest rate of 6% per annum and to use the proceeds to buy back common stock. Assume that there are no taxes.
-
How many shares can the company buy back with the 120 million of new debt that it issues? What is the market value of the firm after the change in the capital structure, assuming the market is perfect? Has the share price changed?
-
What is the debt ratio after the change in capital structure? What is the expected rate of return to equity holders after the change in capital structure?
-
Suppose Executive LUCY pays tax at a marginal rate of 35%. Calculate executive LUCYs after-tax WACC.
-
Briefly explain how corporate tax affects Executive LUCYs firm value and WACC. How can Executive LUCY maximize firm value in the presence of corporate taxes only. Explain your answer and any limitations.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started