In Sept. 2008, the U.S. government seized control of AIG in exchange for $85 billion. Later, the company was given $95 billion more. The justification for the bailout was not just to save AIG, but also to save the financial system - or so it was alleged.

After AIG received its bailout funds, the company started a massive restructuring project by selling many business units to pay off its debt.

AIG after the crises

It is now December 2012 and the business has stabilized. The amount of debt on AIG’s balance sheet is now $10 billion on which AIG pays an interest rate of 7% per year. AIG has $500 million in excess cash remaining from its sale of assets over the previous several years.

AIG’s stock price is $30 per share (on December 31, 2012). AIG has 1.5 billion common shares outstanding. The company’s marginal tax rate is 40%.

a. What is the value of AIG as an unlevered firm (Vu) as of now (i.e., the end of 2012). Please show your analysis.

b. Assume that AIG announces that it will use $500 million of excess cash to retire equity. What will be the share price be just after the announcement?

c. Assume AIG keeps the $500 million excess cash in the firm. Instead AIG announces that it will borrow $1 billion debt to repurchase equity. What will be the share price just after the announcement?