Scenario: Hightower, Inc. plans to announce it will issue $2.0 million of perpet
ID: 2816625 • Letter: S
Question
Scenario: Hightower, Inc. plans to announce it will issue $2.0 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 5%. Hightower, Inc. is currently an all-equity company worth $7.5 million with 400,000 shares of common stock outstanding. After the sale of the bonds, the company will maintain the new capital structure indefinitely. The company currently generates annual pretax earnings of $1.5 million. This level of earnings is expected to remain constant in perpetuity. The tax rate is 35%.
Question: Construct the company's market value balance sheet immediately after the announcement of the debt issue.
Explanation / Answer
VL = VU + TCD
VL = the value of a levered firm
VU = the value of an unlevered firm
TC = the corporate tax rate
D = the value of debt in a firm’s capital structure
PV(Tax Shield) = TCD
= (0.35)($2,000,000)
=$700000
VL = VU + TCD
= $10,000,000 + 700000
VL=10700000
Company's market value balance sheet immediately after the announcement of the debt issue.
Balance Sheet Old Assets 10000000 Debt PV(Tax Shield) 700000 Equity 10700000 Total Assets 10700000 Total Assets 10700000Related Questions
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