Washington Beltway is consulting firm financed entirely by common stock and has 15M shares outstanding with a price of $2 per share. It earnings per share are $0.20 and it has a required return on equity (unlevered) of 10%. It announces that it intends to issue $10M of debt and use the proceeds to buy back common stock at market prices.
a. How many shares should the company be able to buy back with the $10m proceeds from the debt issue (assume no signaling effect from the repurchase)?
b. What is the market value of the firm (equity plus debt) after the change in capital structure assuming no tax or signaling effects?
c. What is the debt–equity ratio (D/E) after the change in structure?
d. If the debt has an expected rate of return equal to 5%, what is the required rate of return on the levered equity of the firm (assuming no debt or signaling issues)?