Question

The firm Jucol has just decided to undertake a major new project. As a result, the value of the firm in one year’s time will be either $120 million (probability 0.25), $250 million (probability 0.5) or $360 million (probability 0.25). The firm is financed entirely by equity and has 10 million shares. All investors are risk-neutral, the risk-free rate is 4% and there are no taxes or other market imperfections.

(a) What is the value of the company and its share price?

Jucol decides to issue debt with face value $146 million due in one year and use the proceeds to repurchase shares now. Assume now that bankruptcy costs will be 15% of the value of the firm’s assets in the event of default on debt repayment.

(b) What is the value of the debt now? What is its yield?

(c) What is the expected value of the firm and the price per share? How many shares will be repurchased?

(d) Assume Jucol decides instead to issue debt with face value $100 million due in one year and repurchase shares with the proceeds. What is the firm’s value now? Why? What is its share price?

(e) Explain how the presence of corporate taxes would influence Jucol’s restructuring decision. (100 words)

Answer 1

Answer:

a).

Calculation of Value of the Firm
Amount in Million $
Expected Value	Probability	Probable value
120	0.25	30
250	0.5	125
360	0.25	90
Value of the firm	245
Number of Shares	10 Million
Share price $	24.5

b). The value of Debt will be the face value of debt issued = $146 Million

The yield will be = 146*4% = $ 5.84 Million

**Since rate of interest on Debt is not given , so it is assumed that risk free rate will be the rate of interest.

c). The expected value of the firm will be the same i.e 245 Million $

The Purchase Price will be = (245-146)/10 Million shares

= 9.9 million $ = 10 million $

The total Number of shares that will be repurchased = 146/10= 14.6 million shares

d).The expected value of the firm will be the same i.e 245 Million $

The Purchase Price will be = (245-100)/10 Million shares

= 14.5 Million $

The total Number of shares that will be repurchased = 146/14.5= 10 million shares