Green Manufacturing, Inc., plans to announce that it will issue $1.96 million of perpetual debt...

Question:

Green Manufacturing, Inc., plans to announce that it will issue $1.96 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 5 percent. Green is currently an all-equity company worth $5.60 million with 360,000 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 $1.46 million. This level of earnings is expected to remain constant in perpetuity. The corporate tax rate is 35 percent.

a. What is the expected return on the company's equity before the announcement of the debt issue?

b. What is the price per share of the company's equity?

c. What is the company's stock price per share immediately after the repurchase announcement?

d-1. How many shares will the company repurchase as a result of the debt issue?

d-2. How many shares of common stock will remain after the repurchase?

e. What is the required return on the company's equity after the restructuring?

MM Proposition with corporate tax:

According to Modigliani and Miller proposition in a world with corporate tax, value of the firm increases with the issuance of debt. As well as they mentioned that debt issue increases the risk for the firm. So the cost of equity for the firm increases.

Answer and Explanation:

a)

Expected return on unlevered equity {eq}R_{0}=\frac{EBIT-Tax}{Equity} {/eq}

Expected return on unlevered equity...

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MM Proposition I & II with Corporate Taxes

from Corporate Finance: Help & Review

Chapter 5 / Lesson 11
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