Description
Resource: Effect of Debt Issuance on Stock Valuation Grading Guide
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 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.
Submit your assignment.
Note: Grades are awarded based upon individual contributions to the Learning Team assignment. Each Learning Team member receives a grade based upon his/her contributions to the team assignment. Not all students may receive the same grade for the team assignment.
Resources
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- Reference and Citation Generator
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- Learning Team Toolkit
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Explanation & Answer
Attached.
Running head: MEMO
1
Debt Issuance on Stock Valuation
Student’s Name
Institutional Affiliation
MEMO
2
Debt Issuance on Stock Valuation
To:
Hightower Inc. Management
From: Student’s Name
Date: 3/14/2019
Subject: Consequence of Debt Issuance on Stock Valuation
According to Cohen and Malburg (2010), notes that a debt issue is a fixed government or
corporate obligations, for example, government bonds as well as the debentures. A debt issue,
therefore, is a financial agreement that allows the issuer to raise capital by promising to repay the
lender on a specified date and in conformity with the contract agreement. Stock valuation, on the
other hand, encompasses the process of determining the profitability of stock for a predicted
future. In capital markets, stock valuation is a discounted cash flow or the income valuation
comprising of dividends, earning as well as cash flows (Thomas & Gup, 2010). Hightower
Corporation intends to announce an issue worth 2.0 million USD perpetual debts and repurchase
the common stock using the attained profits. The plan would result in the realization of a 5
percent coupon rate by selling the bonds at par. Hightower is an all-equity corporation valued at
7.5 million USD and possess 400,000 outstanding shares of common stock. In addition, the
company records pretax earnings of 1.5 million USD annually at a 35 % tax rate. Issuances of
debts and other financial securities intensify the capability of institutions to raise wealth used to
finance operation, expansion projects that are capital intensive.
Hightower Inc. Expected Return before Announcement of Debt Issue
Debt issuance by business leads to a notable influence on the corporate finances,
however, different elements such as changing interest rates affect the expected return positively
or negatively (Jegadeesh, Kräussl, & Pollet, 2015). The expected rate of return is the anticipated
MEMO
3
proceeds expected by an investor. Hightower Inc. debt issuance expects a return of 13 % on the
organization’s equity prior to the declaration of debt issuance by the enterprise. This is the
amount that investors anticipate to gain or lose from the venture for making an investment with
Hightower corporation.
Hightower Inc. Market Worth Balance Sheet before the Declarat...
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