Question

2. Green Manufacturing, Inc., plans to announce that it will issue $2,000,000 of perpetual bonds and use these funds to repurchase equity. The bonds will have a 6-percent coupon rate. Green manufacturing currently is an all-equity firm. The current value of Green’s equity is $10,000,000 and there are 500,000 shares outstanding. After the sale of bonds and share repurchase, Green will maintain the new capital structure indefinitely. Under its current capital structure the expected annual pretax earnings for Green are $1,500,000, and these earnings are expected to remain constant into the foreseeable future. Green is in the 40-percent tax bracket.

1. What Green’s weighted average cost of capital before the debt issue?
2. Construct Green’s market-value balance sheet as it looks before the announcement of the debt issue.
3. Construct the market-value balance sheet after the announcement?
4. How many shares of stock will Green retire?
5. Construct the market-value balance sheet after the debt issue and share repurchase are completed.

Answer 1