Question

Hawar International is a shipping firm with a current share price of $4.96 and 10.8 million shares outstanding. Suppose that Hawar announces plans to lower its corporate taxes by borrowing $20.6 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 $5.21 after this announcement, what is the PV of financial distress costs Hawar will incur as the result of this new debt? a. If the only imperfection is corporate taxes, what will the share price be after this announcement? The share price after this announcement will be $ per share. (Round to the nearest cent.) b. Suppose the only imperfections are corporate taxes and financial distress costs. If the share price rises to $5.21 after this announcement, what is the PV of financial distress costs Hawar will incur as the result of this new debt? The PV of financial distress costs will be $1 million. (Round to two decimal places.)

Answer 1

a). Share Price after announcement = Current Share Price + [tax rate * (Borrowed Amount / Number of shares outstanding)]

= $4.96 + [0.30 * (20.6 / 10.8)] = $4.96 + [0.30 * 1.9074] = $4.96 + $0.57 = $5.53

b). PV of distress costs = [Share Price(if taxes are only imperfections) - Share Price(if taxes and financial distress are only imperfections)] * No. of shares outstanding

= [$5.53 - $5.21] * 10.8 = $0.32 * 10.8 = $3.48 million