ed company operates in perfect markets (no taxes, no bankruptcy costs) and has expected operating income (EBIT) of $2,000,000 per year. The firm’s WACC is 8 percent. The firm has decided to change its capital structure to one that includes some debt. It will do so by issuing $10 million worth of debt with an interest rate of 6.5 percent, and using the proceeds to repurchase outstanding stock. a. What is the market value and required return of this firm’s equity before the repurchase transaction, according to M.M.? b. What is the market value and required return of this firm’s equity after the repurchase transaction according to M.M.?
ed company operates in perfect markets (no taxes, no bankruptcy costs) and has expected operating income (EBIT) of $2,000,000 per year. The firm’s WACC is 8 percent. The firm has decided to change its capital structure to one that includes some debt. It will do so by issuing $10 million worth of debt with an interest rate of 6.5 percent, and using the proceeds to repurchase outstanding stock. a. What is the market value and required return of this firm’s equity before the repurchase transaction, according to M.M.? b. What is the market value and required return of this firm’s equity after the repurchase transaction according to M.M.?
Chapter14: Distributions To Shareholders: Dividends And Repurchases
Section: Chapter Questions
Problem 12P
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Question
An unlevered company operates in perfect markets (no taxes, no bankruptcy costs) and has expected operating
income (EBIT) of $2,000,000 per year. The firm’s WACC is 8 percent. The firm has decided to change its capital structure
to one that includes some debt. It will do so by issuing $10 million worth of debt with an interest rate of 6.5 percent, and
using the proceeds to repurchase outstanding stock.
a. What is the market value and required return of this firm’s equity before the repurchase transaction, according to
M.M.?
b. What is the market value and required return of this firm’s equity after the repurchase transaction according to
M.M.?
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