Problem 16-24 Stock Value and Leverage

Green Manufacturing, Inc., plans to announce that it will issue $2.06 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity firm worth $7.38 million with 460,000 shares of common stock outstanding. After the sale of the bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.56 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 40 percent.

a.	What is the expected return on Greens equity before the announcement of the debt issue? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Expected return

%

b.	What is the price per share of the firms equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Price per share

$

d.	What is Greens stock price per share immediately after the repurchase announcement? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

New share price

$

e-1.	How many shares will Green repurchase as a result of the debt issue? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Shares repurchased

e-2.	How many shares of common stock will remain after the repurchase? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

New shares outstanding

g.	What is the required return on Greens equity after the restructuring? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Required return

%

Problem 16-18 Firm Value

Cavo Corporation expects an EBIT of $21,100 every year forever. The company currently has no debt, and its cost of equity is 13 percent. The corporate tax rate is 35 percent.

a.	What is the current value of the company? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Current value

$

b-1	Suppose the company can borrow at 9 percent. What will the value of the firm be if the company takes on debt equal to 60 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Value of the firm

$

b-2	Suppose the company can borrow at 9 percent. What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Value of the firm

$

c-1	What will the value of the firm be if the company takes on debt equal to 60 percent of its levered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Value of the firm

$

c-2	What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Value of the firm

$