Finance 4310

In Class Problem 9

Firm R is currently an unlevered firm with an EBIT of $800,000 with 400,000 shares

outstanding. The firm is considering issuing $3 million of debt at a before tax cost of 7

percent, and using the proceeds to repurchase stock at the new equilibrium market

price. If this plan is implemented, it is expected that the required return on equity would

increase by 1 percentage point to 9 percent. The firm's marginal tax rate is 34 percent

and the firm pays out all earnings as dividends.

a. What is the value of the unlevered firm?

b. What is the value of the restructured firm?

c. What should the market price of the shares be after the restructuring?

d. How many shares remain after the restructuring?