Question: An all equity firm is subject to a 30 percent tax

An all-equity firm is subject to a 30 percent tax rate. Its total market value is initially $3,500,000. There are 175,000 shares outstanding. The firm announces a program to issue $1 million worth of bonds at 10 percent interest and to use the proceeds to buy back common stock. Assume that there is no change in costs of financial distress and that the debt is perpetual.
a. What is the value of the tax shield that the firm acquires through the bond issue?
b. According to Modigliani & Miller, what is the likely increase in market value per share of the firm after the announcement, assuming efficient markets?
c. How many shares will the company be able to repurchase?

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  • CreatedMarch 26, 2015
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