Effect of Debt Issuance on Stock Valuation

Effect of Debt Issuance on Stock Valuation.

Scenario: Hightower, Inc. plans to announce it will issue $2.0 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 5%. Hightower, Inc. is currently an all-equity company worth $7.5 million with 400,000 shares of common stock outstanding. After the sale of the bonds, the company will maintain the new capital structure indefinitely. The company currently generates annual pretax earnings of $1.5 million. This level of earnings is expected to remain constant in perpetuity. The tax rate is 35%.

Construct the company’s market value balance sheet immediately after the announcement of the debt issue.

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What is the company’s stock price per share immediately after the repurchase announcement?

Effect of Debt Issuance on Stock Valuation

 
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