Consider an all-equity firm CBA. The company's market value is $2,500,000 (2.5m). It is expected to...

 

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Consider an all-equity firm CBA. The company's market value is $2,500,000 (2.5m). It is expected to earn EBIT of $250,000 (250k) forever. Assume further that the free cash flow is equal to EBIT after tax. There are 100,000 shares outstanding. CBA is subject to 30% corporate tax rate. Suppose that the company is issuing $1,000,000 perpetual debt paying 5% interest per year (fair market rate for this company) and uses the money to buy back its stock (stock repurchase). Assume tax savings from debt are as risky as debt. QUESTION: What is the company's stock price after the change in capital structure is announced? Consider an all-equity firm CBA. The company's market value is $2,500,000 (2.5m). It is expected to earn EBIT of $250,000 (250k) forever. Assume further that the free cash flow is equal to EBIT after tax. There are 100,000 shares outstanding. CBA is subject to 30% corporate tax rate. Suppose that the company is issuing $1,000,000 perpetual debt paying 5% interest per year (fair market rate for this company) and uses the money to buy back its stock (stock repurchase). Assume tax savings from debt are as risky as debt. QUESTION: What is the company's stock price after the change in capital structure is announced?

Answer rating: 100% (QA)

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