A leveraged recap, in which Midco would issue debt and use the proceeds to repurchase shares. A Midco industry has 20 million shares outstanding with market price of $15 per share and no debt. The firm has had consistently stable earnings and pays a 35% tax rate. Midco’s investment bankers proposed that the firm borrow $100 million on a permanent basis through a leveraged recap in which it would use the borrowed funds to repurchase outstanding shares.

problem 1: What are the tax consequences of the recap?

problem 2: Based only on the tax effects and the Valuation Principle, what will the total value of the firm be after the recap?

a) How Mach of the new value will be equity?
b) How much will be debt?

problem 3: At what price should Mitco be able to repurchase its shares?

problem 4: Who benefit from the recap, who loses?

problem 5: What other costs or benefits of the additional leverage should Midco’s managers consider?

problem 6: If Midco’s managers decide to issue the debt and distribute the tax shield as the special dividend instead of repurchasing shares, what will the dividend per share be?