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Problem:

An all-equity business has 100 million shares outstanding selling for $20 a share. Management believes that interest rates are unreasonably low and decides to execute a dividend recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.

Required:

Question 1: What is the market value of the firm prior to the recap? What is the market value of equity?

Question 2: Assuming the Irrelevance Proposition holds, what is the market value of the firm after the recap? What is the market value of equity?

Question 3: Do equity shareholders appear to have gained or lost as a result of the recap? Please explain.

Question 4: Assume now that the recap increases total firm cash flows, which adds $100 million to the value of the firm. Now what is the market value of the firm? What is the market value of equity?

Question 5: Do equity shareholders appear to have gained or lost as a result of the recap in this revised scenario?

Note: Please provide step by step solution.

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M91149520

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