effect of debt issuance on stock valuation 12

Purpose of Assignment

The purpose of this assignment is to demonstrate to students how the issuance of debt to purchase outstanding common stock could affect the value of the company’s equity and redefine the capital structure. The problem will also allow students to explore the effect of corporate taxes through debt financing.

Assignment Steps

Resources: Corporate Finance

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%.

Prepare a MEMO advising the management of Hightower, Inc. on the financial impact based on the points below. Make sure to include introduction and conclusion paragraphs that are separate from the body of your paper. Word has templates you can download as it relates to memos. CALCULATIONS SHOULD BE ADDED AS AN APPENDIX. ONLY FINAL ANSWERS SHOULD BE INCLUDED IN THE DISCUSSION. Listed below are the ONLY two questions that I want answered for this assignment.

  • Construct the company’s market value balance sheet immediately after the announcement of the debt issue.
  • What is the company’s stock price per share immediately after the repurchase announcement?