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    Capital Structure- MM theory

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    An all equity financed firm has 10 million shares outstanding. The firm has perpetual EBIT of $20 million. Its current cost of equity is 10%. The firm plans to issue a perpetual bond with $1,000 FV, 10% annual coupon, and 10% YTM. A total of 10,000 units of such bond will be issued.

    Use perpetuity concept to evaluate a perpetual bond.

    Funds raised from the bonds will be used to repurchase outstanding shares. The effective tax rate is 30% at the corporate level.

    According to the MM theory, what is the initial change in equity value upon the announcement of the debt for equity exchange?

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    Solution Preview

    Please see the attached file.

    An all equity financed firm has 10 million shares outstanding. The firm has perpetual EBIT of $20 million. Its current cost of equity is 10%. The firm plans to issue a perpetual bond with $1,000 FV, 10% annual coupon, and 10% YTM. A total of 10,000 units of such bond will be issued.
    Use perpetuity concept to evaluate a perpetual bond.
    Funds raised from the bonds will be used to repurchase outstanding shares. The effective tax rate is 30% at the corporate level.
    According to the MM theory, what is the initial change in equity value upon the ...

    Solution Summary

    Answers a question on repurchasing equity by issuing debt.

    $2.19

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