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A firm currently has no debt. The firm has 10 million shares outstanding and those shares currently have the market price of $30 per share. The firm is contemplating selling $50 million in bonds and using the proceeds to repurchase shares of stock. When they undertake this action, the firm proposes to keep this level of debt financing for the foreseeable future.

Suppose that the corporate tax rate is 40%. Given this data, if the firm announces which they will sell the bonds and repurchase equity what:

(a) Do you expect the stock price to be immediately after announcement?

(b) Will be the firm’s total market value of equity immediately after announcement?

(c) Do you expect the stock price to be after the bond issue/repurchase is completed?

(d) Will be the firm’s total market value of equity after the bond issue/repurchase is completed?

Financial Accounting, Accounting

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