Company X currently has no debt.The Market Value of its 15 million outstanding shares is 25 Euros.The newly hired Financial manager is convinced that this Zero Debt capital structure is not optimal; Debt financing increases the global market value of the company's securities by the present value of the corporate tax shield in interest payments.Operating EBIT are expected to be 105 Million Euros; the tax rate is 34%.The financial director plans to repurchase half of the outstanding shares at 25 Euros / share.The repurchased shares will be financed by issuing 187.5 Million in 8% perpetual debentures.
a) What is the current Value of the Firm?( with Zero debt)
b) What rate does the Market require on the unlevered shares?
c) How much is the tax shield on the 187.5 Million Debt?
d) What should the leverage effect on the return and the Market value of equity on a per share basis be?
e) What should the firm's cost of capital after issuing debt and retiring some equity be?
The current Value of the Firm( with Zero debt)
No. of equity shares Outstanding* Market Price per share
What rate does the Market require on the unlevered shares?
EBIT are expected to be 105 Million Euros; the tax rate is 34%.
Less Taxes 35.7
EPS 4.62 EAT/No. of Equity shares
Return 18.48% EAT/Market Value
Ke = Net Income/Total Market value of ...
This solution explains the valuation of firm through a numerical illustration.