Exam (elaborations)
Bman 23000 Tutorial 3 Solutions
- Institution
- The University Of Manchester (UOM)
This is a unique document that contains tutorial 3 solutions on Bman 23000. Essential!! To your success in Manchester!!
[Show more]
Seller
Follow
Content preview
Semester 2, 2018/19Dr. Stefan Petry
FOUNDATIONS OF FINANCE
PROBLEM SET 3: Capital structure I - SOLUTIONS
Question 1: Recapitalizing to capture the tax shield
Assume that Midco Industries wants to boost its stock price. The company currently has 20
million shares outstanding with a market price of $15 per share and no debt. Midco has had
consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $100 million
on a permanent basis and they will use the borrowed funds to repurchase outstanding shares.
a) What is Midco’s value without leverage?
b) What will the total value of the levered firm be and what will be the value of equity?
c) Assume Midco repurchases its shares at the current price of $15/share. What will the new
share price be?
d) What is the total gain to shareholders?
e) In an efficient market, what would happen at the repurchase announcement?
Answer:
a) What is Midco’s value without leverage?
Without leverage
VU = (20 million shares) × ($15/share) = $300 million
b) What will the total value of the levered firm be and what will be the value of equity?
If Midco borrows $100 million using permanent debt, the present value of the firm’s future tax
savings is
PV(interest tax shield) = τcD = 35% × $100 million = $35 million
Thus the total value of the levered firm will be
VL = VU + τ cD = $300 million + $35 million = $335 million
Because the value of the debt is $100 million, the value of the equity is
E = VL − D = $335 million − $100 million = $235 million
1
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller anyiamgeorge19. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £8.53. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
73243 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now