PLEASE ANSWER THE FOLLOWING QUESTION \"ASAP\"... 12. An all-equity business has

Question

PLEASE ANSWER THE FOLLOWING QUESTION "ASAP"...

12. An all-equity business has 100 million shares outstanding selling for
$20 a share. Management believes that interest rates are unreasonably
low and decides to execute a dividend recapitalization (a recap). It will
raise $1 billion in debt and repurchase 50 million shares.
a. What is the market value of the firm prior to the recap? What is the
market value of equity?
b. Assuming the Irrelevance Proposition holds, what is the market
value of the firm after the recap? What is the market value of
equity?
c. Do equity shareholders appear to have gained or lost as a result of
the recap? Please explain.
d. Assume now that the recap increases total firm cash flows, which
adds $100 million to the value of the firm. Now what is the market
value of the firm? What is the market value of equity?
e. Do equity shareholders appear to have gained or lost as a result of
the recap in this revised scenario?

Explanation / Answer

a) Market Value = 100*20 = $2000 million = $2 billion Market value of equity would remain same = $2 billion b) Market value would remain same after recap. Only market capitalization would reduce to half. Market value of equity = 1 billion c) Buying back shares increases stock price showing confidence of the company in its working. Hence, investors gets capital gains. d) New market value = 2 billion + 100 million = 2.1 billion Market value of equity would increase by 100 million. Hence, 1.1 billion e) Equity shareholders have gained due to market recap

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.