It is Wednesday evening, June 3^rd, 2020. Martin Wolf is the Chief Financial Officer at AiTech, a British publicly listed online pharmacy company, which is an all-equity financed firm with zero debt. As a financial advisor to the AiTech, you have a dinner reservation with Martin Wolf at 7 pm at the Canary Wharf, London.

I must take the recapitalisation plan seriously says Martin. We are considering a recapitalisation plan that would convert AiTech from its all-equity capital structure to one including substantial financial leverage adds Martin.

AiTech is an unlevered firm operates in perfect markets and has net operating income (EBIT) of 2,000,000 per year for the foreseeable future. Assume that the required return on assets for firms in this industry is 8 per cent. The firm issues 10 million worth of debt, with a required return of 6.5 per cent, and uses the proceeds to repurchase outstanding shares. There are no corporate or personal taxes. Martin shares the following information with you so that you can evaluate the effect of financial leverage.

Table 1: Current and Proposed Capital Structure of AiTech

To help Martin in recapitalisation, you had to go through various documents of AiTech. You have noticed that in the last three years, Martin did not undertake many positive net present value (NPV) long term projects related to very important Artificial Intelligent technology. You have also found that AiTech had the necessary funds to undertake these projects. Your initial assessment indicates that had these projects been undertaken, AiTech could have become the leader in such technologies: the firm could grow at a faster pace compared to the pace it is growing now, and thus shareholders would have been wealthier.

Since the outbreak of the Covid-19 pandemic, AiTech is considering to merge with BioTech Ltd. BioTech Ltd is a biotechnology firm, undertaking innovative research to develop new treatments. Currently, BioTech is working on Covid-19 vaccine: if BioTech can develop a vaccine, it stands to make a substantial financial gain from it. The CEO of AiTech thinks that a vertical merger with BioTech would bring a considerable synergy to the merged entity.

q1)Assume NO corporation tax: following MM Proposition I & II, you must calculate the market value and required return of AiTechs share before the repurchase transaction.

Table 1: Current and Proposed Capital Structure of AiTech Current (Unlevered = -U) 25,000 25,000 o Assets Equity Debt Debt-to-equity ratio Shares outstanding Share price Interest rate on debt Figures in thousands Proposed (Levered = L) 25,000 15,000 10,000 0.67 133.3 125.00 6.5% 0 200 125.00