Solutionschapter17

# Solutionschapter17 - 14 a) The company is currently an...

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14 a) The company is currently an all-equity firm, so the value as an all-equity firm equals the present value of aftertax cash flows, discounted at the cost of the firm’s unlevered cost of equity. So, the current value of the company is: VU = [(Pretax earnings)(1 – tC)] / R0 VU = [(\$35,000,000)(1 – .35)] / .20 VU = \$113,750,000 The price per share is the total value of the company divided by the shares outstanding, or: Price per share = \$113,750,000 / 1,500,000 Price per share = \$75.83 b. The adjusted present value of a firm equals its value under all-equity financing plus the net present value of any financing side effects. In this case, the NPV of financing side effects equals the aftertax present value of cash flows resulting from the firm’s debt. Given a known level of debt, debt cash flows can be discounted at the pretax cost of debt, so the NPV of the financing effects are: NPV = Proceeds – Aftertax PV(Interest Payments) NPV = \$40,000,000 – (1 – .35)(.09) (\$40,000,000) / .09 NPV = \$14,000,000 So, the value of the company after the recapitalization using the APV approach is: V = \$113,750,000 + 14,000,000 V = \$127,750,000 Since the company has not yet issued the debt, this is also the value of equity after the announcement. So, the new price per share will be: New share price = \$127,750,000 / 1,500,000 New share price = \$85.17 c. The company will use the entire proceeds to repurchase equity. Using the share price we calculated in part b, the number of shares repurchased will be: Shares repurchased = \$40,000,000 / \$85.17 Shares repurchased = 469,667 And the new number of shares outstanding will be:

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## This note was uploaded on 11/02/2011 for the course FIN 320 taught by Professor Staff during the Fall '08 term at Ill. Chicago.

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Solutionschapter17 - 14 a) The company is currently an...

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