Purpose of Assignment
The purpose of this assignment
is to demonstrate to students how the issuance of debt to purchase outstanding
common stock could affect the value of the company’s equity and redefine the
capital structure. The problem will also allow students to explore the effect
of corporate taxes through debt financing.
Assignment Steps
Resources:Corporate Finance
Scenario: Hightower, Inc. plans to
announce it will issue $2.0 million of perpetual debt and use the proceeds to
repurchase common stock. The bonds will sell at par with a coupon rate of 5%.
Hightower, Inc. is currently an all-equity company worth $7.5 million with
400,000 shares of common stock outstanding. After the sale of the bonds, the
company will maintain the new capital structure indefinitely. The company
currently generates annual pretax earnings of $1.5 million. This level of
earnings is expected to remain constant in perpetuity. The tax rate is
35%.
Prepare a 1,050-word memo
advising the management of Hightower, Inc. on the financial impact, including
the following:
·
What is the expected return on
the company’s equity before the announcement of the debt issue?
·
Construct the company’s market value balance sheet before the announcement
of the debt issue. What is the price per share of the firm’s equity?
·
Construct the company’s market
value balance sheet immediately after the announcement of the debt issue.
·
What is the company’s stock
price per share immediately after the repurchase announcement?
·
How many shares will the company
repurchase as a result of the debt issue? How many shares of common stock will
remain after the repurchase?
·
What is the required return on
the company’s equity after the restructuring?
·
Discuss the advantages and
disadvantages of debt financing over equity financing.
Show all
calculations and submit with your memo.
Format your paper consistent
with APA guidelines.
I’m responsible for the portion highlighted in RED. This is a group
assignment.
Assignment is due: Saturday, March 4th by 8:00am.
