Question

Hawar International is a shipping firm with a current share price of $ 5.47 and 10.9 million shares outstanding. Suppose that Hawar announces plans to lower its corporate taxes by borrowing $ 20.3 million and repurchasing​ shares, that Hawar pays a corporate tax rate of 30 %​, and that shareholders expect the change in debt to be permanent. a. If the only imperfection is corporate​ taxes, what will the share price be after this​ announcement? b. Suppose the only imperfections are corporate taxes and financial distress costs. If the share price rises to $ 5.72 after this​ announcement, what is the PV of financial distress costs Hawar will incur as the result of this new​ debt?

Answer 1

a) Price of share after announcement = Tax savings on debt issued per share + market price of share

=(0.3*20.3 mln /10.9 mln) + 5.47$

=0.5587$ + 5.47$

=6.0287$

b) PV of Distress call = (Theoritical value of share price after announcement less actual price after announcement) * no. of shares
=(6.0287-5.72)*10.9 mln shares
= $ 3.3648 mln