Problem 24. Stock Value and Leverage

Green manufacturing plan to announce that it will issue $2 million 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 $6.3 million with 400,000 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 $1.5 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax of 40 percent.

Questions

1). Construct the market value balance sheet after restructuring.

2). What is the required return on Greens equity after restructuring?