Question

A firm in mine industry generates risky cash flows with an expected value of $ 750, 000 per year (perpetuity). Using direct tracking method of valuation, the CFO of the firm has found that in order to replicate the cash flows, the amount of money invested in the market portfolio (i.e., the term b) needs to be equal to the amount of money invested in the risk-free asset (i.e., the term a).

The financial market is mean-variance efficient, the safe rate of interest is 5 percent, and the market expected return is 10 percent. The firm has an outstanding debt with a market value of $ 1 million. The debt is risk-free. The number of outstanding shares is 1 million.

The corporate tax rate is 30%.

i) What is the firm value?

ii) What is the share price?

Suppose that this mining firm plans to borrow an additional $100,000 on a permanent basis through a leveraged recapitalization in which it would use the borrowed funds to repurchase outstanding shares. After the new borrowing, the debt is still risk-free.

iii) What is the share price after the capital structure change is completed?

iv) How many shares are repurchased?

Answer 1

- Amore (1) perfety Cash flows from (WAC) Value of from cash flows - cost of copint → (Equal weight Rhon Exputed ois (4) 5% as 0.5&slot for muret 7.5. - Rob fee Roky. Value of firms 750,00 19,000,000 $ » Value of hare Value of from C-7 Value of dent of No. of hares = 10,000,000 (-) 1,000,000 Bebt mit valin 4 $9 pere Share a 22 Valued share after - colpisal torudure a . Value of Equity after studere No- of shares after a v Let qt of Let me ay heres Reprechant be x . ay & lawas gren) Prece value of share 900g ou to xy 1000,00 OX canng witle 9ooo ou 100000 am Vanner o ou 12

Date Page -) (2000000 yg x by Stavano 9109, ooo - lerooomo y psy Glooms Looooooy go, oo, ao y = 4 9 per share Hense pria of share after chouchure = Um $19 fer share zey = looro x= looous az 11111 . 11 shares. Nocanhed Share cambscanner to be repurchased a 11111. 11 shares.