3) Global Pistons has common stock with a market value of $200 million and debt with value of $100 million.
Investors expect a 15% return on the stock and a 6% return on the debt. Assume perfect capital markets.
a) Suppose GP issues $100 million of new stock to buy back the debt. What is the expected return of the stock after this transaction?
b) Suppose instead GP issues $50 million of new debt to repurchase stock.
****if the risk of the debt doesn't change what is the expected return of the stock after this transaction?
5) Your fim currently has $100 million in debt outstanding with a 10% interest rate. The terms of the loan require the firm to repay $25 million of the balance each year.
Suppose that the marginal corp tax rate is 40% and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt?
Solution Preview
ANSWERS
Please see attached file for answers.
Question 3
Based on Modigliani and Miller, the value of the firm is independent of its capital structure, hence the weighted cost of capital under any ...
Solution Summary
The stock issues versus debt and repurchase of stocks are examined.
... changes regarding the taxation of dividends versus capital gains. ... plan in which the firm would issue long-term ... and use the proceeds to repurchase common stock. ...
... or lack thereof) through determining the actual return versus the current ... analyze, issuing $1 billion in debt to repurchase stock, and issuing $1 billion ...
... of the company's capital structure ( amount of on- versus off-balance ... Cons 1) Debt ratings may not provide the best ... it has to raise $500,000 by a stock issue. ...
... exceed net income, the firm should pay zero dividends and issue stock (or else increase its debt ratio to fund the ... s for dividends versus capital gains. ...
... tax interest savings on the convertible issue versus a straight ... The bottom line on the tax issue depends on ... If one stock is somehow rewarded for a particular ...
... Asset Specificity (general purpose vs. ... in the correct path as it is reducing the cost of capital by repurchasing the stock and effectively issuing the debt...
... selling prices that can be charged versus the prices ... The firm has 25,000 shares of stock outstanding. Management is considering issuing $100,000 of debt at an ...
