GloboChem is an all-equity firm with expected (annual) free cash flow of $100M next year. Free cash flow is expected to grow 2% thereafter in perpetuity. The company's unlevered cost of capital is 10%, its tax rate is 35% and it has 100M shares outstanding. GloboChem has decided to borrow sufficient funds so that it attains a D/V ratio of 25% (debt-to-equity of 0.3333). It pledges to maintain that proportional capital structure in perpetuity. The new debt will be used to repurchase an equal value of shares each year. The company's cost of debt is 5%. 

Use this information to answer the following questions.
 

a. What is the return on equity for the levered firm, k E ?
b. What is the WACC for GloboChem?
c. What is the market value of the firm after the debt issue and repurchase? (Hint: Use a DCF valuation.)
d. What is the market value of the debt? (Recall that D/V = 25%)
e. The company uses the proceeds from the debt issue to repurchase shares. How many shares are repurchased and how many are left outstanding if the company repurchased shares at $12.50/share?
f. What is the percentage increase in the stock price after the debt issue and repurchase?
g. Given what you just learned, would you have sold any shares during the repurchase for $12.50 per share?
h. What price would prevail after the repurchase if the company paid $13.22 per share?

Answer rating: 100% (QA)

a The return on equity for the levered firm kE can be calculated using the following formula kE kU kU kD DE Where kU is the unlevered cost of capital kD is the cost of debt and DE is the debttoequity ... View the full answer