Stock Validation

Anonymous
timer Asked: May 8th, 2018
account_balance_wallet $25

Question description

This is what I need done. Just about 250 words no more.

Introduction

  • Discuss the advantages and disadvantages of debt financing over equity financing.

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.

I ONLY NEED AN INTRODUCTION

AND DISCUSS THE ADVANTAGES AND DISADVANTAGES OF DEBT FINANCING OVER EQUITY FINANCING

NO MORE THAN 250 WORDS

Hightower Inc. Appendix 1 Balance sheet before Announcement Total Assets $7,500,000 Debt $0 Equity $7,500,000 Total debt + equity $7,500,000 Balance sheet after Announcement Total Assets $8,200,000 Debt $0 Equity $8,200,000 Total debt + equity $8,200,000 Expected returns $1,500,000 pretax value 35% tax rate 1,500,000 x 35% = $525,000 ($1,500,000 -$525,000 ) / $7,500,000 = 13% Price per share before Announcement Price per share = total market value / no. of common shares outstanding Total market value = $7,500,000 Common shares outstanding = 400,000 Price per share = 7,500,000 / 400,000 = $18.75 Price per share after Announcement Price per share = total market value / no. of common shares outstanding Total market value = $8,200,000 Common shares outstanding = 400,000 Price per share = 8,200,000 / 400,000 = $20.50 VL = VU + TC B VL = value of levered firm VU = value of unlevered firm TCB = present value of tax shield on debt Debt issue - $2,000,000 35% tax rate, and present value of tax shield = 35% x $2,000,000 = $700,000 Expected Return When discussing expected returns, this references the after-tax earnings relative of the market value of equity. We can calculate the return by taking product of the pretax earnings of $1.5 million times the tax rate of 35%, divided by the equity ($7.5), thus 13%. This value represents the expected return on equity before the debt issue. Company market value before announcement & stock price Hightower Inc. is planning on a $2 million issuance of debt. Before this is announced, it is worthwhile to understand the company’s balance sheet. As shown in appendix 1, the company has equity worth $7.5 million with 400,000 shares of common stock. The value is all equity based. The current stock price is $18.75 and is the result of taking the equity value into the current shares. It will be an advantageous move in the investors eyes for the company to issue. Company market value after announcement & stock price When Hightower Inc. announces the debt issue, the tax shield will increase the value of levered firm. The company currently has $2,000,000 of debt issue value and will seek to increase by the present value of the tax shield of $700,000. Taking the equity value of $7,500,000 plus the tax shield value, the total after announcement value will be $8,200,000. The after-announcement balance sheet is shown on appendix 1. The purpose of this announcement is to use the proceeds to repurchase common stock. Once the announcement has occurred, the company stock price will increase. Calculating the new price of stock will take the equity value by the common shares outstanding, the new price will be $20.50 (calculation in appendix 1). The increase of pricing shows investors that the company is poised for growth.

Tutor Answer

CASIMIR
School: UT Austin

Here you go. In case o...

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Review

Anonymous
Awesome! Exactly what I wanted.

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