Question
Use the following information to answer questions in Problem 1 (below) and Problem 2 (next page): An unlevered (all-equity) firm has 250,000 common shares trading
Use the following information to answer questions in Problem 1 (below) and Problem 2 (next page): An unlevered (all-equity) firm has 250,000 common shares trading at $80 per share. With its investment plan fixed, it is expected to generate a perpetual EBIT stream of $3 million per year. The corporate tax rate is 40%. The firm is contemplating taking on debt by issuing a $10 million face value perpetual bond carrying 5% coupon interest per year and using the proceeds to retire some of its stock outstanding. a) What rate of return will shareholders require before the firm changes its capital structure? b) What will be the firm value after the firm changes its capital structure? c) What will be the firms cost of equity after the firm changes its capital structure? d) What will be the share price after the firm changes its capital structure? e. Suppose you are holding 100 shares bought at $80 per share just before the firm changes its capital structure. How much capital gain tax will you pay by selling your 100 shares just after the firms change its capital structure. Assume that the capital gain will be taxed at half of the 40% corporate tax rate?
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