Expert answer:Effect of Debt Issuance on Stock Valuation

Expert answer: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 FinanceScenario: 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 1,050-word memo advising the management of Hightower, Inc. on the financial impact, including the following: What is the expected return on the company’s equity before the announcement of the debt issue?Construct the company’s market value balance sheet before the announcement of the debt issue. What is the price per share of the firm’s equity?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?How many shares will the company repurchase as a result of the debt issue? How many shares of common stock will remain after the repurchase?What is the required return on the company’s equity after the restructuring?Discuss the advantages and disadvantages of debt financing over equity financing. Show all calculations and submit with your memo. Format your paper consistent with APA guidelines.3 references
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Effect of Debt Issuance on Stock
Valuation Grading Guide
FIN/571 Version 9
Foundations of Corporate Finance
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Effect of Debt Issuance on Stock
Valuation Grading Guide
FIN571 Version 9
Learning Team Assignment: Effect of Debt Issuance on Stock Valuation
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.
Resources Required
Corporate Finance
Grading Guide
Content
Prepared a 1,050-word memo advising the
management of Hightower, Inc. on the
financial impact of the provided scenario.
Used the following questions to prepare the
memo:
•
•
•
•
•
•
•
What is the expected return on the
company’s equity before the
announcement of the debt issue?
Construct the company’s market
value balance sheet before the
announcement of the debt issue.
What is the price per share of the
firm’s equity?
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?
How many shares will the company
repurchase as a result of the debt
issue? How many shares of common
stock will remain after the
repurchase?
What is the required return on the
company’s equity after the
restructuring?
Discuss the advantages and
disadvantages of debt financing over
equity financing.
Showed all calculations.
Met
Partially
Met
Not Met
Comments:
2
Effect of Debt Issuance on Stock
Valuation Grading Guide
FIN571 Version 9
Content
Met
Partially
Met
Not Met
Total
Available
Total
Earned
5
#/5
Partially
Met
Not Met
Total
Available
Total
Earned
2
#/2
7
#/7
Comments:
Formatted your paper consistent with APA
guidelines.
Writing Guidelines
Met
The paper—including tables and graphs,
headings, title page, and reference page—is
consistent with APA formatting guidelines and
meets course-level requirements.
Intellectual property is recognized with in-text
citations and a reference page.
Paragraph and sentence transitions are
present, logical, and maintain the flow
throughout the paper.
Sentences are complete, clear, and concise.
Rules of grammar and usage are followed
including spelling and punctuation.
Assignment Total
Additional comments:
#
Comments:
3
…
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