Question

Refi Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt-equity ratio is expected to rise from 40 percent to 50 percent. The firm currently has $3.2 million worth of debt outstanding. The cost of this debt is 7 percent per year. The firm expects to have an EBIT of $1.31 million per year in perpetuity and pays no taxes. a. What is the market value of the firm before and after the repurchase announcement? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) b. What is the expected return on the firm’s equity before the announcement of the stock repurchase plan? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) c. What is the expected return on the equity of an otherwise identical all-equity firm? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) d. What is the expected return on the firm’s equity after the announcement of the stock repurchase plan? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

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- 2x Σ AutoSum : A Fill 2 Sort & m Find & Insert Delete Format 2 Clear Filter Editing Select Cells GQ GR GS GT GU 926 928 931 PV, FV, ANNUITY (Autosaved) - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Calibri -11AA = = = Dr Wrap Text General Ea Copy Paste B I U B- E A E E s FMerce Format Painter Merge & Center - Center $ % % , 4.0 .00 :.: Conditional Format Cell Formatting as Table Styles Clipboard Font Alignment Number Styles GM945 - foc GIG GK GL GM GN GO GP А WHEN TAXES ARE ABSENT 927 VALUE OF LEVERED FIRM = VALUE OF UNLEVERED FIRM IF DEBT-EQUITY RATIO = 40% AND DEBT = 3200000 929 VALUE OF EQUITY = 3200000/40% = 8000000.00 930 VALUE OF FIRM = VALUE OF EQUITY + VALUE OF DEBT 932 VALUE OF FIRM = 8000000 + 3200000= 11200000.00 933 934 VALUE OF FIRM DOES NOT CHANGE WHEN TAXES ARE NOT THERE 935 SO VALUE OF FIRM WILL BE SAME BEFORE AND AFTER REPURCHASE ANNOUNCEMENT 936 937 EBIT = 1310000 938 INTEREST = 224000 [3200000 X 7%] 939 EBT = 1086000 940 TAXES = 941 NET INCOME = 1086000 942 RETURN ON EQUITY BEFORE REPURCHASE ke = 13.58% [NET INCOME/VALUE OF EQUITY] 943 944 K L pv, fv, annuity CAP STRU VALUE profit margin loan with points LOCK BOX DILUTION DOLLAR COST AVG EXPO NPER APR CPI ear FVA OAN OPTIONS ferences pva 52 53 BOJ 130% Red 0 + ELEB * * OENG 02-11-2019

- 2x Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Cells GO GP GQ GR GS GEGUE SO PV, FV, ANNUITY (Autosaved) - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Calibri -11AA = = = Dr Wrap Text General Ea Copy Paste B I U B- A Merge & Center - Format Painter $ % , :.: Formatting as Table Styles Clipboard Font Alignment Number Styles GL955 - for GIGGK GL GM GN 945 946 с EXPECTED RETURN ON EQUITY FOR AN UNLEVERED FIRM 947 AS THERE ARE NOT TAXES, THE VALUE OF UNLEVERED FIRM = VALUE OF LEVERED FIRM 948 ROE = 1310000/11200000 = 11.70% [ko] 949 950 AFTER REPURCHASE PLAN 951 ke = KO +(ko-kd)(D/S) 952 ke = 11.7% +(11.7%-7%) (0.5) ke = 14.05% 954 955 956 957 958 959 960 961 953 962 H 963 N Rea CAP STRU VALUE profit margin loan with points LOCK BOX DILUTION DOLLAR COST AVG EXPONPER APR CPI ear FVA 0 0 LOAN OPTIONSpv, fv, annuity ferences pva 52 BO 53 130% _ 0 + EJEND O ENG 02-11-2019