Healius Limited is one of Australias leading listed healthcare companies. Healius is a service company to medical and allied health professionals. A broad range of medical and related services are offered in Healiuss network of medical centres and pathology centres across Australia. Healius is also a leading provider of healthcare technology solutions to medical practitioners, medical practices and hospitals.

Healiuss market capitalisation currently runs at about $1,899 million, with a debt-to-equity ratio of approximately 1:6. The companys CFO is currently recommending that the Board issue new debt worth 10% of the firms existing debt in order to repurchase shares for the same amount. He is advocating for a recapitalisation of the firms balance sheet in order to realise an increase in firm value by having a higher debt level. The debt issue will take the form of a 10-year corporate bond with a yearly coupon equal to the firms current cost of debt of 4.3%.

Healiuss CFO has approached Access Economics for assistance in formulating a solid argument for the proposed increase in financial leverage. While there is a tax advantage associated with debt financing, the team at Access Economics are concerned with the more subtle considerations about personal taxes at the investor level that also need to be taken into account. The consulting team will therefore consider three different tax settings:

A world with no taxes

A world with corporate taxes only

A world with taxes paid on all levels

Healiuss marginal corporate tax rate is 30%. Assume that the marginal personal tax rate on income from debt is 35% and that the marginal personal tax rate on income from equity is 28%.

Required:

On behalf of Access Economics, prepare a presentation and written brief for the board of directors of Healius Limited, addressing the following requirements:

1. Calculate the effective tax advantage of using debt.

2. Determine the present value of the interest tax shield for each of the three tax settings.

a. Draw a timeline with the years from 1 to 10.

b. Calculate the interest payment on the bonds for each year.

c. Calculate the interest tax shield in each of the three tax settings.

d. Calculate the present value of the interest tax shield in each of the three tax settings.

3. Determine the new share price and number of shares outstanding in each of the three tax settings.

a. Assume that the current market value of Healiuss equity is based on a current share price of $3.05 and total shares outstanding of 622,700,000.

b. Determine the new market value of equity if the share repurchase occurs.

c. Determine the share price at which shareholders are willing to sell their shares given the information about the new debt. Note: Format the share price with three or four decimals, as the differences in share price might be less than one cent.

d. Determine the number of shares outstanding after the repurchase.