Question
Kurz Manufacturing is an all-equity firm with 30M shares outstanding that are priced at $25.00 per share. Suppose that Kurz announces that tomorrow it will
Kurz Manufacturing is an all-equity firm with 30M shares outstanding that are priced at $25.00 per share. Suppose that Kurz announces that tomorrow it will issue $200M worth of debt and use that borrowed cash to pay a special dividend of $200M. The debt contract promises to pay interest of $10M per year for fifteen years, and to repay the face value of $200M at maturity (t=15). Assume that the discount rate for debt payments and tax shield cash flows is 5%. Also assume a corporate tax rate of 35% and zero taxes on dividends and capital gains.
a) What is Kurzs share price immediately after the debt is issued but before the dividend is paid? (Hint: share price is value of equity divided by number of shares outstanding. The value of equity will increase by the value of the tax shield.)
b) What is Kurzs share price immediately after the dividend is paid?
c) Answer parts (a) and (b) again, but now assume that the debt contract promises to pay interest of $10M per year in perpetuity.
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