Question

An all-equity business has 145 million shares outstanding selling for $20 a share. Management believes that interest rates are unreasonably low and decides to execute a leveraged recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.

b. Assuming the Irrelevance Proposition holds, what is the market value of the firm after the recap? What is the market value of equity? (Enter your answers in billions rounded to 1 decimal place.)

C. Assume now that the recap increases total firm cash flows, which adds $190 million to the value of the firm. Now what is the market value of the firm? What is the market value of equity? (Enter your answers in billions rounded to 2 decimal places.)

Answer 1

Ans:- (b) Market Value of the firm will be given by Number of outstanding shares * Value per share

= $20 * 145 million = $2,900 million = $2.9 billion.

After the recap Market value will remain the same i.e $2.9 billion.

Market Value of equity will be ( 145 million - 50 million ) * $20 = $1900 million = 1.9 billion

(c) If the recap increases $190 million of cash flow then the

Market value will be 2,900 million + $190 million = $3,090 million = $3.09 billion.

The market value of equity increase by $190 million = $1900 million + 190 million = 2090 million = $2.09 billion.

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