Firm C currently has 250,000 shares outstanding with current market value of $42.00 per share and generates an annual EBIT of $1,250,000. Firm C also has $1 million of debt outstanding. The current cost of equity is 8 percent and the current cost of debt is 5 percent. The firm is considering issuing another $2 million of debt and using the proceeds of the debt issue to repurchase shares (a pure capital structure change). It is estimated that the cost of the new debt will be 5.5 percent and that the cost of equity will rise to 8.48 percent with the additional debt. The marginal tax rate is 30 percent.

1. What is the current market value of the firm?
2. Before the capitalization, what is the firm's weighted average cost of capital? Answer in decimal form.
3. What will the firm's market value be after the announcement of the new debt issue?
4. What will the estimated new share price be after the capital structure change announcement?

5.What is the firm's net income after the recapitalization?

Note: The total interest costs that must be subtracted from EBIT must be calculated in two parts and then added:

6.How many shares are outstanding after the repurchase?

Answer rating: 100% (QA)

1 Current market value of the firm Shares outstanding x Current share price ... View the full answer