The NEWT Company is located in a country where there are no taxes and there are

ID: 2723009 • Letter: T

Question

The NEWT Company is located in a country

where there are no taxes and there are

perfect capital markets so that there are no bankruptcy costs. The corporation currently

has $25 million in debt outstanding and the value of its equity is $75 million. The return

on its equity is 15% and the return o

n its debt which is currently risk free is 8%. Suppose

NEWT decides to issue $15 million additional debt and use it to repurchase $15 million

of equity. The new debt is expected to be risk free after the issue. All the debt, both

before and after the refin

ancing, consists of perpetuities.

(a) What is the total value of the firm after the refinancing?

(b) What would the return on the equity be after the refinancing

Answer to Part (a) Total Value of the firm after refinancing = MArket value of debt + Market value of Equity

Market value of Debt after refinancing = 25 million + 15 million = 40 Million

Markt value of Equity after refinancing = 75 million - 15 million = 60 million

Total Value of firm after refinancing = 40 miilion + 60 million = $ 100 million

Answer to Part (b) Return of Equity after refinancing :

Value of Equity after refinanncing = 60 Million

Return on Equity= 15%

Return on Equity after refinancing = 15% on 60 million = 9 million

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