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problem1. An all-equity business has 100 million shares outstanding selling for $20 a share. Management thinks that interest rates are unreasonably low and decides to perform a dividend recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.

a. What is market value of firm prior to the recap? What is market value of equity?

b. Supposing the Irrelevance Proposition holds, what is market value of firm after the recap? What is the market value of equity?

c. Do equity shareholders appear to have gained or lost as a result of recap? Please describe.

d. Suppose now that the recap raises 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 market value of equity?

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

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