Solved Question: Firm A has 1000 shares of stock

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Firm A has 1000 shares of stock

It has a Flat perpetual cash flow of $800 equal to annual EBIT

As an unlevered firm it has no debt and an unlevered beta of .8

Rf = 5% and market risk premium = 5%

Assume a 25% tax rate

a)     What is the firm’s unlevered stock currently worth per share

b)    The manager has vowed to never issue equity. But now, he is convinced to do the following. Assume the firm issues sufficient perpetual debt to repurchase stock with the end result being 20% debt and 80% equity financing of the total firm market value. If the debt is risk free with a required 5% return and the firm says it will keep the debt as is without adjustments forever and the market believes it:

i.               What is the new cost of equity? What is the new WACC

ii.              What is the new value of the firm (Debt + Equity)? What is the value of equity?

iii.       What is the new share price of the firm?

iv.            What is the number of shares repurchased? (hint: figure out what stock would trade for when debt issue is announced and about to be done when figuring price to buy back stock at)


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