Custom Writing Service-EFFECT OF DEBT ISSUANCE ON STOCK VALUATION

Custom Writing Service-EFFECT OF DEBT ISSUANCE ON STOCK VALUATION

The purpose of this assignment is to  demonstrate to students how the issuance of debt to purchase outstanding  common stock could affect the value of the company’s equity and  redefine the capital structure. The problem will also allow students to  explore the effect of corporate taxes through debt financing. 

Hightower, Inc. plans to announce it will  issue $2.0 million of perpetual debt and use the proceeds to repurchase  common stock. The bonds will sell at par with a coupon rate of 5%.  Hightower, Inc. is currently an all-equity company worth $7.5 million  with 400,000 shares of common stock outstanding. After the sale of the  bonds, the company will maintain the new capital structure indefinitely.  The company currently generates annual pretax earnings of $1.5 million.  This level of earnings is expected to remain constant in perpetuity.  The tax rate is 35%.

What is the expected return on the company’s equity before the announcement of the debt issue?

Construct the company’s market value balance sheet before the  announcement of the debt issue. What is the price per share of the  firm’s equity?

Construct the company’s market value balance sheet immediately after the announcement of the debt issue.

What is the company’s stock price per share immediately after the repurchase announcement?

How many shares will the company repurchase as a result of the debt  issue? How many shares of common stock will remain after the repurchase?

What is the required return on the company’s equity after the restructuring?

Discuss the advantages and disadvantages of debt financing over equity financing.