#Two Capital Structure • A firm has 200,000 stocks outstanding at a market price

ID: 2811974 • Letter: #

Question

#Two

Capital Structure

• A firm has 200,000 stocks outstanding at a market price of 50 and no debt

• The firm plans to issue 3,000 bonds at a market value of 1,000

• The proceeds from the issuance will be immediately paid to shareholders as a special dividend

(a) (2 points) Compute the value of one stock before the issuance.

(b) (2 points) Compute the value of one stock after the issuance

(d) (4 points) Is there creation/destruction of value for shareholders? Explain why.

Answer:

a) Value of one stock before the issuance of bonds = Market price of stock = 50

b) Value of one stock after the issuance of bonds:

Value of bonds issued = 3000*1000 = 3000000

Dividend per share = 3000000/200000 = 15 per share

So Value of stock after issuance = 50 - 15 = 35 per share

c) Dividend amount paid by one stock :

Value of bonds issued = 3000*1000 = 3000000 and this amount is used to pay dividends

Dividend per share = 3000000/200000 = 15 per share

d) There is neither creation nor destruction of shareholders wealth.

As before dividend, value per share was 50

After dividend, value for shareholders = 35 + 15 = 50

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