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To: Hightower Inc. Management.
RE: Advice on Financial Impact
This memo has been addressed to the management of Hightower Inc. to give advice on
the financial impact of the company. The details of the following are discussed in the memo. The
return that is expected on the company's equity before the announcement of the debt issue, the
market value balance sheet of the Hightower company before the announcement of the debt
issue, the price per share of the firm's equity, the market value balance sheet immediately after
the announcement of the debt issue of the company, the stock price per share immediately after
the repurchase announcement of the company, the number of shares repurchased by the company
as a result of the debt issue, the number of shares of common stock that will likely remain after
the repurchase, the required return on the company's equity after the restructure and the
advantages and disadvantages of debt financing over equity financing as seen in the company.
The return on a firm’s equity that is expected can be described as the ratio of annual
after–tax earnings to the market value of equity of the firm. It measures the company’s
profitability by telling how much of a profit the company makes with the amount invested by
shareholders and investors. Hightower Inc. should expect $1,500,000 of pre–tax earnings per
year. The firm is subjected to a corporate tax rate of 35%, it must for this reason pay $525,000
worth of taxes every year. This is found from 35% of the pretax earnings= (35/100*$1,500,000).
Hightower’s after–tax annual expected earnings are ($1,500,000 – $525,000) =$975,000. The
market value of Hightower’s equity is $7,500,000. The expected return on Hightower’s
unlevered equity therefore is ($975,000 /$7,500,000) =0.13 or 13%. If the company’s return falls
below this amount, then the investment would be considered unwise which is not the case. If it
so happens investors would refuse to invest bringing a fall in the company. This though proves
that the investment is worthwhile.
Hightower is an all-equity firm that provides financial backing and makes investments in
the private equity of startup and operating companies through loosely affiliated investment
strategies. The value of the firm’s after tax earnings currently is ($975,000/0.0013) =$6,300,000.
Below is the Hightower’s market value balance sheet before the announcement of the debt is:
Total Assets =
7,500,000 Total D + E = $
Total equity $7.5= million
Total earnings $1.5= million
shareholder’s equity is the difference between total assets and total liabilities =
The price per share of Hightower Inc.is given by the company’s stock price=
($11,000,000/400,000) =$27.50 per share. The $11million from adding the company’s debt to
the all equity company worth and the annual earning, ($7.5 million+ $2.0 million +1.5 million)
This price per share will be good or bad to the company depending on the demand and supply of
Hightower’s market value balance sheet immediately after the announcement of the debt is:
Old Assets =
PV(Tax Shield) =
Total Assets =
$ 7,500,000 Debt =
$ 700,000 Equity =
$ 8,200,000 Total D + E = $ 8,200,000
The equity together with the debt equals a total of $8,200,000. Hightower’s stock price per share
immediately after the repurchase announcement is given from: the new value for Hightower Inc.
of $8,200,000, debt amount of $2,000,000 to repurchase common stock, equity value of
$8,200,000 minus $2,000,000 which is $6,200,000. This represents the real value of the
investor’s stake in the investment and hence important. This is not bad for the company since it
is not negative which occurs when the asset’s value is less than its liabilities
The company's stock price per share immediately after the repurchase announcement is
therefore ($8,200,000 / $400,000) =$20.50. This repurchase depending with the market
conditions will prove if the price is fair. This repurchase should also be able to be discontinued if
the prices become unfair
The number of shares that Hightower will repurchase due to the debt issue will be
calculated as the amount of the debt issue divided by the new share price. This repurchase is
important in that it will allow the company to return cash to its shareholders. The shares
repurchased therefore = ($2,000,000/$20.50) which gives a result of 97,560.9756 shares which
could be rounded up to 97,560.98 shares. The number of shares of common stock that will
remain after the repurchase is (400,000-97,560.98) which gives the balance shares as 302439.02.
this will be important in getting money back to the investors which could be important for the
The return as required on the company's equity after the restructuring is calculated using
the following formulae rs = ru + (B/S) (ru – rb) (1 – tc), where ru represents the return on
unlevered equity =0.13, B represent market value of debt = $2 million, S representing market
value of equity = $7.5 million rb the return on debt=0.35 and tc the tax = 0.35. Using this
calculation, Hightower Inc. has a required return on the equity after the restructure of 14.68%.
Advantages and Disadvantages of Debt financing over equity financing
In view of the company’s current undertakings the following are the advantages and
disadvantages of debt financing over equity financing as seen. Borrowing money helps a
company to maintain ownership which in turn helps the management have complete control over
decisions it makes on behalf of the company. With this it can as well choose its own board
members. The lender has no authority to dictate on how the money should be spent hence retained
control. Another advantage of debt financing is that when a company pays interest on debt, they
receive tax deductions. In many countries revenue authorities consider interest paid as expense on
the business and allow the ownership to deduct payment from their corporate income ta...