Question

24. Stock Value and Leverage.  Green Manufacturing, Inc.,plans to announce that it will issue $1.6 million of perpetual debt and use the proceeds to repurchase common stock.  The bonds will sell at par with an annual coupon rate of 6 percent.  The company is currently an all-equity firm worth $7.7 million with 260,000 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 $1.86 million.  This level of earnings is expected to remain constant in perpetuity.  The corporate tax rate is 40 percent.  

a. Whatis the expected return on equity before the announcement of the debt issue?

b. Construct the market value balance sheet before the announcement of the debt issue.  What is the price per share of the firm's equity?

c.  Construct the market value balance sheet immediately after the announcement of the debt issue.

d. What is the stock price per share immediately after the repurchase announcement?

e. How many shares will the company repurchase as a result of the debt issue?  How many shares of common stock will remain after the repurchase?

f.  Construct the market value balance sheet after the restructuring.

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

Answer 1