1. CCH, Inc. has no debt in its capital structure. There are 100 million shares
ID: 2789966 • Letter: 1
Question
1. CCH, Inc. has no debt in its capital structure. There are 100 million shares outstanding and the price per share is $30. The company is considering a debt-for-equity swap where they will issue $1 billion in debt at a 6% coupon rate (YTM-696) and use the proceeds to buy back stock (at $30 per share). Calculate the following: If there are no taxes, what is the value of the firm without tax if after the debt-for- equity swap is completed? Show your calculation a. b. If there are taxes that apply at a 35% rate, what is the value of the firm after the debt is issued? Show your calculation If the firm issued more debt so that its debt/equity ratio was 10, what would be the value of the firm (including taxes but ignoring bankruptcy costs)? Show your calculation c.Explanation / Answer
When debt = 0, value of unlevered firm = 30*100 = $3000 million = $3 billion
Now debt comes into the picture. In such a situation, value of the firm is increased by tax shield.
Cost of debt is 6%
a:
Tax = 0
Debt = $1 billion
Value of levered firm = Value of unlevered firm + PV of tax-shield
As taxes are zero, tax-shield is also zero.
Value of levered firm = Value of unlevered firm = $3 billion
b:
Tax = 35%
Value of levered firm = 3 + 1*0.35 = $3.35 billion
c:
D/E = 10, D/A = 10/11, E/A = 1/11
Debt = 3*(10/11)
Value of levered firm = 3 + 3*(10/11)*0.35 = $3.95 billion
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