Locomotive Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firms debtequity ratio is expected to rise from 35 percent to 50 percent. The firm currently has $3.6 million worth of debt outstanding. The cost of this debt is 8 percent per year. Locomotive expects to have an EBIT of $1.35

Locomotive Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 35 percent to 50 percent. The firm currently has $3.6 million worth of debt outstanding. The cost of this debt is 8 percent per year. Locomotive expects to have an EBIT of $1.35 million per year in perpetuity. Locomotive pays no taxes.

a. What is the market value of Locomotive Corporation before and after the repurchase announcement?

b. What is the expected return on the firm’s equity before the announcement of the stock repurchase plan?

c. What is the expected return on the equity of an otherwise identical all-equity firm?

d. What is the expected return on the firm’s equity after the announcement of the stock repurchase plan?

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Corporation
A Corporation is a legal form of business that is separate from its owner. In other words, a corporation is a business or organization formed by a group of people, and its right and liabilities separate from those of the individuals involved. It may... Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...