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An all-equity business has 200 million shares outstanding selling for $30 a share. Management believes that...

An all-equity business has 200 million shares outstanding selling for $30 a share. Management believes that interest rates are unreasonably low and decides to execute a leveraged recapitalization (a recap). It will raise $750 million in debt and repurchase 25 million shares.

a. What is the market value of the firm prior to the recap? What is the market value of equity?

b. Assuming the irrelevance proposition holds, what is the market value of the firm after the recap? What is the market value of equity?

c. Do equity shareholders appear to have gained or lost as a result of the recap? Please explain.

Expert Solution

Answer :-

a. What is the market value of the firm prior to the recap? What is the market value of equity?

Given data ,

Equity business = 200 million shares

Outstanding selling price = $30 a share

Market value = Equity business * Outstanding selling price

= 200 million shares * $30 a share

= $6,000 millions

= $6 billions

Market value = $6 billions

Market value of equity is also same .

Market value of equity = $6 billions

b. Assuming the irrelevance proposition holds, what is the market value of the firm after the recap? What is the market value of equity?

Market esteem would stay same after recap. Just market capitalization would diminish to half .

Market value of equity = $6 billions / 2

= $3 billions

Market value of equity = $3 billions

c. Do equity shareholders appear to have gained or lost as a result of the recap? Please explain.

Repurchasing shares builds stock value indicating certainty of the organization in its working.
Hence,investors gets capital increases .

ekkarill92 answered 2 years ago

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