Question

The firm is an all-equity firm with assets worth $350 million and 100 million shares outstanding. It plans to borrow $100 million and use these funds to repurchase shares. The firm’s marginal corporate tax is 21%, and it plans to keep its outstanding debt equal to $100 million permanently. If the firm manages to repurchase shares at $4 per share, what is the per share value of equity for the leveraged firm?

A) $2.71 per share B) $3.5 per share C) $3.61 per share D) $3.71 per share E) $4 per share

Answer 1

Given,

Assets = $350 million

Shares outstanding = 100 million shares

Tax rate = 21% or 0.21

Debt = $100 million

Solution :-

Value of unlevered firm = Assets = $350 million

Value of levered firm = value of unlevered firm + Debt + (debt x tax rate)

= $350 million + $100 million + ($100 million x 0.21)

= $350 million + $100 million + $21 million = $471 million

Value of equity of levered firm = value of levered firm - debt

= $471 million - $100 million = $371 million

Per share value of equity for the levered firm = Value of equity of levered firm/shares outstanding

= $371 million/100 million shares = $3.71 per share