Green Manufacturing, Inc., plans to announce that it will issue $2.06 million of
ID: 2427490 • Letter: G
Question
Green Manufacturing, Inc., plans to announce that it will issue $2.06 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity firm worth $7.38 million with 460,000 shares of common stock outstanding. After the sale of the bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.56 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 40 percent.
What is the expected return on Green’s equity before the announcement of the debt issue? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
What is the price per share of the firm’s equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
What is Green’s stock price per share immediately after the repurchase announcement? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
How many shares will Green repurchase as a result of the debt issue? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
How many shares of common stock will remain after the repurchase? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
What is the required return on Green’s equity after the restructuring? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Green Manufacturing, Inc., plans to announce that it will issue $2.06 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity firm worth $7.38 million with 460,000 shares of common stock outstanding. After the sale of the bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.56 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 40 percent.
Explanation / Answer
Green Mnaufacturing Inc Details Amt Present worth 7,380,000 Common stocks Outstanding 460,000 Price /stock 16.04 Current EBIT 1,560,000 Tax rate 40% Post Tax income 936,000 Assume expected return on equity before repurchase=k So 936000/k=7380000 k= 12.68% a So Expected return on Green's Equity= 12.68% b Price per share= $ 16.04 d Debt amount 2,060,000 e1 No of shares that will be repurchased= 128,429 e2 No Of shares remaining after repurchase= 331,571 Firm value after repurchase=7380000+0.40*2060000 = $ 8,204,000 Value of share after repurchase= 24.743 g Required return after repurchase; Debt Value 2,060,000.00 Equity value after repurchase= 5,320,000.00 Debt Equity ratio=D/E 0.39 Cost of debt =Kd 6% Tax rate =T 40% Cost of unlevered equity =Ku 12.68% Cost of levered Equity= Ku+(1-T)*D/E*(Ku-Kd) =12.68+0.6*0.39*6.68 =14.24% Cost cost of equity after repurchase=14.24%
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