Question 3 (25 marks) CorVIR Inc. is a firm whose operations generate an expected EBIT (earnings before interest income, interest expenses and corporate taxes) of $80 per year in perpetuity. These are all the cash-flows that the firms' operating assets are generating, and the company is currently all- equity financed. Given the risk of CorVIR's operations, the market requires a return of 15%, i.e., the unlevered cost of capital is 15% for these cash-flows. In addition to its operating assets, CorVIR holds $150 of excess cash on its balance sheet, which is invested in Treasury-bills generating a risk-free return of 4% every year before corporate taxes. The corporate tax rate is 40%. CorVIR is listed on a stock exchange and has 1,000 shares outstanding. i. Assume the market believes that CorVIR will keep the $150 of cash on its balance sheet forever and never take on any debt. What is the market value of CorVIR's equity and the price of CorVIRs stock? (Hint: Excess cash invested in treasury is similar to carrying negative debt and therefore features tax disadvantage that is opposite to the usual interest tax shield) (6 marks) Now assume that Cor VIR announces that the firm will undertake a leveraged recapitalisation. In this transaction, CorVIR will take on $250 of new permanent fixed debt and use the proceeds from the debt issue, together with the $150 of cash it already holds, to pay a special dividend to shareholders of $400 (40 cents per share). Assume that the risk of the tax shield of the debt is the same as the risk of the debt. The interest rate on the debt will be 6%. ii. What will happen to the price of CorVIRs stock when this recapitalisation plan is announced? (6 marks) iii. Assume now that Cor VIR goes ahead with this recapitalisation, i.e., raises $250 of debt and pays a dividend of $400. What will be the market values of CorVIRs equity and debt after this transaction has been completed? What will be the stock price? What is the change in total shareholder value from this transaction (vis--vis the case before the transaction was announced)? (7 marks) iv. Assume now that CorVIR, instead of paying a dividend, uses the $400 (the excess cash plus the proceeds from the debt issue) to repurchase its own shares. How many shares will CorVIR be able to acquire? What will be the stock price of CorVIR after the share buyback? What is the change in shareholder value from this transaction (vis--vis the case before the transaction was announced)? (6 marks)