The TQM Corporation is located in a country where there are perfect capital markets and no...

The TQM Corporation is located in a country where there are perfect capital markets and no taxes.... The TQM Corporation is located in a country where there are perfect capital markets and no taxes. The corporation currently has $120 million in equity and $60 million in risk free debt. The return on equity, rS, is 18% and the cost of debt, rB, is 9%. Suppose TQM decides to issue additional equity to repurchase the $60 million in debt so that it will have an all-equity capital structure.

1. If TQM did this, what would the total value of the firm be after the refinancing?

2. What would the return on equity, rS, be after the refinancing?

3. Before the refinancing, a shareholder, Sheila, holds $1 million of TQM stock and $2 million of risk free debt. What is her holding of TQM stock and risk free debt after the refinancing, if she wants to keep the same level of risk in her portfolio?

4. After the refinancing, suppose the firm announces a project costing $5 million with an NPV of $2 million. Investors do not anticipate the project. The project is to be financed entirely by debt. What is the total value of the firm's equity after the debt for the project has been raised?

Expert Solution

1. The total value of the firm will be same as the value of its equity which is going to be $ 180 million

2. The cost of equity will be at 18% (same as before the event) however the WACC will increase since there will be no debt.

3. Prior to refinancing, TQM has $120 million in equity and $60 million in debt. Hence Sheila through her $1 million TQM stock had equity holding of 2/3 and debt holding of 1/3 through TQM. Hence her pesonal holding across equity & debt was : Equity = 2/3 * 1000000 = 666,666.67

Debt = 2000000 + 1/3 * 1000000 = 2,333,333.33

After refinancing, her TQ holding will be all equity hence her holding pattern will be :

Equity = 1 million and Debt = 2 million.

If she wants to keep her portfolio break down at earlier levels, then she should sell the TQM stock for $333,333.33 and purchase risk free debt for the same .

4. The firm value should increase by the NPV value - hence the value will be $182 million

jeff jeffy answered 2 years ago

Consider a world with no taxes and perfect capital markets. The WW Corporation is currently all...

Consider a world with no taxes and perfect capital markets. The WW Corporation is currently all equity financed. Its earnings are $10M per year and will stay that way in perpetuity. The value of the firm is $120M. The firm is considering issuing risk-free debt worth $50M and maturing in 10 years at an interest rate of 6% and using it to repurchase $50M of equity. Ivan owns $1.5M of the stock of WW before the refinancing. By how much...

(10) This is a world with NO TAXES (perfect capital markets). The firm is a no...

(10) This is a world with NO TAXES (perfect capital markets). The firm is a no growth firm and pays out all of its earnings as dividends. It is originally all equity financed (unlevered). The firm decides to issue $500,000 in debt to repurchase stock. The cost of debt is 4%. Fill in ALL the missing values in the table. Unlevered Levered EBIT 200,000 200,000 INTEREST Earnings (Net Income) #Shares 20,000 Ru 8% 8% RE EPS Price Value of the...

Suppose that capital markets are perfect, meaning that they are complete, efficient and there are no...

Suppose that capital markets are perfect, meaning that they are complete, efficient and there are no frictions such as taxes. AH Belo Corp currently is 100% equity financed, with a market capitalization of $1 billion but has decided to add some debt to its capital structure. It will do so by raising $100 million in debt and using the proceeds to repurchase shares. Which of the following accurately describes the effect of this policy change on the company's stock price?...

If the region or country where a company is located is experiencing a labor shortage, what...

If the region or country where a company is located is experiencing a labor shortage, what should the company's management do? Rightsize the staff Downsize the staff Decrease remedial budgets Suspend the recruitment process Increase training budgets

Assume perfect capital markets. Since the debt claim is senior to the equity claim, debt is...

Assume perfect capital markets. Since the debt claim is senior to the equity claim, debt is cheaper than equity. Therefore, a simple strategy to reduce the cost of capital would be to take on as much debt as possible. DISCUSS this claim concisely.

True/False: In the context of perfect capital markets, suppose a firm increases the proportion of debt...

True/False: In the context of perfect capital markets, suppose a firm increases the proportion of debt in its capital structure, but leaves all other aspects of its business unchanged. Taken together, the Modigliani-Miller Propositions tell us that the firm’s increased reliance on the relatively cheap debt financing is perfectly offset by a rise in the required return paid to shareholders (as well as a potential rise in the required return paid to debt holders), such that the value of the...

Under the M&M world with perfect capital markets, the cost of equity is independent of its...

Under the M&M world with perfect capital markets, the cost of equity is independent of its capital structure. True False Under the M&M world with perfect capital markets, a firm’s value should rise with increased leverage because debt is cheaper than equity. True False Under the M&M world with perfect capital markets, a firm’s average cost of capital (i.e. pre-tax WACC) falls for increases in debt as long as the firm avoids truly excessive leverage. True False

this question above .A country which adopts a fixed exchange rate system with perfect capital mobility...

this question above .A country which adopts a fixed exchange rate system with perfect capital mobility should implement expansionary monetary policy to increase the aggregate income level, Do you agree with this statement and why you agree..i want explaination.

Section 2: Capital Structure An unlevered company operates in perfect markets and has earnings before interest...

Section 2: Capital Structure An unlevered company operates in perfect markets and has earnings before interest and taxes (EBIT) of $3m. Assume that the required return on assets for firms in this industry is 10%. The firm issues $15m worth of debt with a required return of 6% and uses the proceeds to repurchase outstanding stock. There are no corporate or personal taxes. a) What is the market value of the firm and required return of this firm’s stock before...

Country Markets has an unlevered cost of capital of 11.45 percent, a tax rate of 35...

Country Markets has an unlevered cost of capital of 11.45 percent, a tax rate of 35 percent, and expected earnings before interest and taxes of $18,700. The company has $11,000 in bonds outstanding that have an 8 percent coupon and pay interest annually. The bonds are selling at par value. What is the value of WACC?

Question