Firm C currently has 320,000 shares outstanding with current market value of $33

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 percent and the current cost of debt is 6 percent. 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 percent and that the cost of equity will rise to 10 percent with the additional debt. The
marginal tax rate is 34 percent.

a. What is the current market value of the firm?
b. What will the firm

Explanation / Answer

d. $3,000,000/34.74=$86,355.79

shares outstanding = 320,000-86355.79= 233,644

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