Malcolm Schwartz returned home after spending the afternoon meeting with his firm's investment bankers. Schwartz is CFO of Comico SMAC, a mid-sized manufacturing firm, and he was taking a hard look at its capital structure and payout policy. Schwartz felt that Comico SMAC was potentially not taking full advantage of the tax benefits of debt. Further complicating matters, Comico SMAC's institutional investors had been demanding either a repurchase or a special dividend. One possibility suggested by Comico SMAC's investment bankers was a "leveraged recap," in which Comico SMAC would issue debt and use the proceeds to repurchase shares. Comico SMAC has 25 million shares outstanding, with a market price of $16 per share and no debt. The firm has had consistently stable earnings and pays a 32% tax rate. Comico SMAC's investment bankers proposed that the firm borrow $120 million on a permanent basis through a leveraged recap in which it would use the borrowed funds to repurchase outstanding shares. As Malcolm sat down at his desk, he stared at her notepad. David, his grandson, returning from finance class wanted to try out his newly acquired expertise. Malcolm had written down several questions that he would need to answer before making his decision. How would David answer the following? CASE I QUESTIONS 1. What are the tax consequences of the recap? 2. Based only on the tax effects and the Valuation Principle, what will the total value of the firm be after the recap? a. How much of the new value will be equity? b. How much will be debt? 3. At what price should Comico SMAC be able to repurchase its shares? 4. Who benefits from the recap? Who loses? 5. What other costs or benefits of the additional leverage should Comico SMAC's managers consider? 6. If Comico SMAC's managers decide to issue the debt and distribute the tax shield as a special dividend instead of repurchasing shares, what will the dividend per share be