Question
The company has been 100% equity firm with no debt. Shares of Finance Experts (FEX) sell for $100 per share and there are 1 million
The company has been 100% equity firm with no debt. Shares of Finance Experts (FEX) sell for $100 per share and there are 1 million shares outstanding. The company generates an average of $10 million net operating income (EBIT) per year and is subject to 30% tax. Finance Experts board of directors ask Charles about changing the capital structure of the firm to 80% equity and 20% debt by issuing debt and using the funds to repurchase FEX shares. The firm can issue debt at 5% interest.
a. What is the current value of theunleveredfirm?
b. How much debt should be issued?
c.What is the tax benefit (total value of tax shield) of the new capital structure?
d. What are the returns on equity (ROE) before the capital restructure and after the capital restructure?
e. What are earnings per share before the restructure and after the restructure?
f. What are the WACC for the firm before the restructuring and after the restructuring?
Hint: first figure out how much debt would buy back 20% of the company and how many shares that corresponds to.
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