Firm C currently has 320,000 shares outstanding with current market value of $33
ID: 2627037 • Letter: F
Question
Firm C currently has 320,000 shares outstanding with current market value of $33 per share and generates an annual EBIT of $1,500,000. Firm C also has $1 million of debt outstanding. The current cost of equity is 9% and the current cost of debt is 6%. The firm is considering issuing another $3 million of debt and using the proceeds of the debt issue to repurchase shares (a pure capital structure change). It is estimated that the cost of the new debt will be 7% and that the cost of equity will rise to 10% with the additional debt. The marginal tax rate is 34%.
What is the current market value of the firm?
What will the firm's market value be after the announcement of the new debt issue?
What will the estimated new share price be after the capital structure announcement?
How many shares are outstanding after the repurchase?
Explanation / Answer
What is the current market value of the firm?
V0 = $11,560,000
What will the firm's market value be after the announcement of the new debt issue?
V1 = $12,118,000;
What will the estimated new share price be after the capital structure announcement?
P1 = $34.74;
How many shares are outstanding after the repurchase?
n1 = 233,644.
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