Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

The price per share of your all-equity firm is $40, and there are 2M shares outstanding. Suppose that your firm issues $30M worth of debt.

The price per share of your all-equity firm is $40, and there are 2M shares outstanding. Suppose that your firm issues $30M worth of debt. The debt has a face value of $30M, a coupon rate of 5 percent per year, and 15 years until maturity. The discount rate (expected return) on this debt and the tax shield cash flows from this debt is 5 percent. Assume a tax rate of 40 percent.

  1. a) What is the new price per share after issuing this debt? (Hint: the share price will increase because of the valuable tax shield on the new debt.)

  2. b) Ten years pass, meaning that there are five years left until the debt matures. The share price has since increased to $60 because the firm has performed reasonably well in the last ten years. There are still 2M shares outstanding. Your firm announces that today it will repurchase and retire the outstanding debt. Thus, the firm will no longer receive the remaining tax shield cash flows over the next five years. What is the change in the share price after this announcement?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

a To calculate the new price per share after issuing the debt we need to consider the tax shield effect on the firms value The tax shield is the present value of the tax savings resulting from the int... blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Document Format ( 2 attachments)

PDF file Icon
664305fb3cdd7_952995.pdf

180 KBs PDF File

Word file Icon
664305fb3cdd7_952995.docx

120 KBs Word File

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Corporate Finance

Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe

13th International Edition

1265533199, 978-1265533199

More Books

Students also viewed these Finance questions

Question

What is meant by equity financing? What is meant by debt financing?

Answered: 1 week ago