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Stock Buy Back Decision on a Zero Growth Firm

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An short analysis (sheet) needs to be prepared using excel to decide whether the proposal should be accepted or rejected.

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You have the following data on Joe's Corporation:
EBIT: $1,000,000
Tax rate: 40%
Cost of equity: 10%

Joe's is a zero growth firm, and is currently financed entirely with equity (in other words, it currently has no debt).
One of the corporate officers has suggested that since interest rates are so low, Joe might be better off if he borrowed some money and used it to buy back stock, thereby making use of debt financing in the firm. He presents the following data in his analysis:
Amount of debt proposed: $1,000,000
Interest rate: 6%
New cost of equity after the money after the money is borrowed: 12%

Joe has come to you for advice. Prepare an analysis for him that indicates whether or not the proposal should be accepted.

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Solution Preview

See the attached file for complete solution. The text here may not be copied exactly as some of the symbols / tables may not print. Thanks
You have the following data on Joe's Corporation:

EBIT: $1,000,000
Tax rate: 40%
Cost of equity: 10%

Joe's is a zero growth firm, and is currently financed entirely with equity (in other words, it currently has no ...

Solution Summary

The solution evaluates a stock buy back proposal to recommend whether it should be accepted or not in an Excel attachment.

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e. The bonds become subordinated to another debt issue.

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Mini Case Page 415

a. Describe briefly the legal and privileges of common stockholders.
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