Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs. Toy retailer CICE is an unlevered firm with a share price of €20.00 per share and with 20 million shares outstanding. CICE pays a 30% corporate tax rate. Suppose CICE announces plans to lower its corporate taxes by borrowing €200 million and using the proceeds to repurchase shares. CICE’s shareholders expect this change in debt to be permanent.

If the price of CICE’s stock rises to €22.50 per share following the announcement, then the present value of CICE’s financial distress costs will be closest to ?

Answer rating: 100% (QA)

The increase in share price can be attributed to the decrease in corporate tax rate resulting from t... View the full answer