Question
Mason Manufacturing, Inc. plans to announce that it will issue $6 million of perpetual debt and use the proceeds to repurchase its stock. The bond
Mason Manufacturing, Inc. plans to announce that it will issue $6 million of perpetual debt and use the proceeds to repurchase its stock. The bond will sell at par with an annual coupon rate of 5%. The firm is currently an all-equity firm worth $20 million with 1 million shares outstanding. After the sale of the bonds, the company will maintain the new capital structure indefinitely. The company currently generates annual pretax earnings of $2 million. This level of earnings is expected to remain constant in perpetuity. The corporate tax rate is 25%.
a) What is the firms cost of equity before the announcement?
b) What happens to the stock price per share upon the announcement?
c) After the restructuring is completed, what is the cost of equity after the announcement? What is the weighted average cost of capital?
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