Q4. (20 points) ZeroLeverage Co. is a manufacturing company. It is expected to earn $500,000 EBIT on average per year and forever. It always distributes all its net earnings as dividends to shareholders. The company faces a 40% corporate tax rate. ZeroLeverage Co. is so far fully equity financed. There are 100,000 shares of common stocks outstanding and the stock price per share is $20. Recently, the CEO of ZeroLeverage Co., Mr. Peter Kyle, attended a Corporate Finance class. He learned that different capital structure may have some impacts on firm value. Due to the company's stable earnings performance and limited debt liability, many investment banks and financial advisors have approached Mr. Peter Kyle about the possibility of issuing new bonds. Mr. Peter Kyle wants to know if it is a good idea to issue additional debt and use the proceeds to buy back shares. To be specific, Mr. Peter Kyle is thinking about offering $1 million perpetual debt paying 10% interest rate and using the money to buy back some shares of the outstanding common stocks. Please help him evaluate the following questions. For questions (a)-(d), assume there is no bankruptcy cost. a. (3 Points) What is the current market value of ZeroLeverage Co.? What is the current WACC? b. (3 Points) What is the market value of ZeroLeverage Co. after it issues $1 million perpetual bond paying 10% interest rate per year and uses the money to buy back some shares of common stocks? c. (6 Points) What is the cost of equity and WACC of ZeroLeverage Co after it issues the debt? d. (5 Points) If ZeroLeverage Co. issues $1 million perpetual debt and uses the money to buy back some shares of common stocks, how many shares of common stocks could it buy back and what is the new stock price? e. (3 Points) What are possible relationships between capital structure and firm value under MM theorem without corporate tax and bankruptcy cost, under the MM theorem with only corporate tax, under the MM theorem with both corporate tax and bankruptcy cost? Q4. (20 points) ZeroLeverage Co. is a manufacturing company. It is expected to earn $500,000 EBIT on average per year and forever. It always distributes all its net earnings as dividends to shareholders. The company faces a 40% corporate tax rate. ZeroLeverage Co. is so far fully equity financed. There are 100,000 shares of common stocks outstanding and the stock price per share is $20. Recently, the CEO of ZeroLeverage Co., Mr. Peter Kyle, attended a Corporate Finance class. He learned that different capital structure may have some impacts on firm value. Due to the company's stable earnings performance and limited debt liability, many investment banks and financial advisors have approached Mr. Peter Kyle about the possibility of issuing new bonds. Mr. Peter Kyle wants to know if it is a good idea to issue additional debt and use the proceeds to buy back shares. To be specific, Mr. Peter Kyle is thinking about offering $1 million perpetual debt paying 10% interest rate and using the money to buy back some shares of the outstanding common stocks. Please help him evaluate the following questions. For questions (a)-(d), assume there is no bankruptcy cost. a. (3 Points) What is the current market value of ZeroLeverage Co.? What is the current WACC? b. (3 Points) What is the market value of ZeroLeverage Co. after it issues $1 million perpetual bond paying 10% interest rate per year and uses the money to buy back some shares of common stocks? c. (6 Points) What is the cost of equity and WACC of ZeroLeverage Co after it issues the debt? d. (5 Points) If ZeroLeverage Co. issues $1 million perpetual debt and uses the money to buy back some shares of common stocks, how many shares of common stocks could it buy back and what is the new stock price? e. (3 Points) What are possible relationships between capital structure and firm value under MM theorem without corporate tax and bankruptcy cost, under the MM theorem with only corporate tax, under the MM theorem with both corporate tax and bankruptcy cost
