A firm consists of assets that will produce cash flows of $450 one year from today if the economy is good and $150 if the economy is bad. The economy is good or bad each with 50% probability. The risk-free rate and market risk premium are zero and there are no taxes. The firm has 100 shares outstanding and debt with a face value of $200 due at the end of the year.

 

a) What is the share price of the firm?

Suppose that the firm unexpectedly announces that it will issue additional debt, with the same seniority as existing debt (i.e., pari passu) and a face value of $100. The firm will use the entire proceeds to repurchase some of its outstanding shares.

b) What is the market price of the new debt?

c) Just after the announcement, what will the price of a share jump to?

Answer rating: 100% (QA)

a What is the share price of the firm To calculate the share price of the firm we need to first calculate the expected cash flow of the firm This can ... View the full answer