Indoor Gear Ltd has an all-equity capital structure with shares currently valued at $20,000. However, it is considering borrowing $11,000 to repurchase shares at the current market value. The interest rate on this borrowing is 4% p.a. The expected net operating income is expected to remain the same at $5,000 per annum in perpetuity. The corporate tax rate is 30%.

i) Show that after the buy-back, the market value of the equity will be $12,300.

ii) Calculate the equity holder’s after-tax required rate of return before and after the buy-back.

Answer rating: 100% (QA)

i Unlevered Value of Equity 20000 Levered Value of Equity before buy b... View the full answer