1. A firm currently has equity with a market value of $500 million and debt with a market value of $500 million. The firm has 10 million shares outstanding. The bonds offer investors a return of 8%.

1. A firm currently has equity with a market value of $500 million and debt with a market value of $500 million.  The firm has 10 million shares outstanding.  The bonds offer investors a return of 8%.  The firm is contemplating issuing $250 million in new equity and using the proceeds to repurchase $250 million of the firm’s debt.  The corporate tax rate is 35%, the effective personal tax rate on equity income is 10% and the effective personal tax rate on interest income is 20%. 

(a) What will the firm’s stock price be immediately after the firm announces its refinancing plan?

(b) How many shares will the firm issue?

(c) What is the market value of the firm’s (i) debt and (ii) equity immediately before the refinancing plan is announced?

(d) Calculate the market value of the firm’s (i) debt and (ii) equity immediately after the refinancing plan is announced (but before it is actually executed).

(e) Calculate the market value of the firm’s (i) debt and (ii) equity after the equity issue and bond repurchase are completed.

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