Effect of Debt Issuance on Stock Valuation, homework help

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Business Finance

Description

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 in Excel and submit with your memo. ( Excel spreadsheet with formulas and calculations must b atached to the assignment)

Format your paper consistent with APA guidelines.

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Explanation & Answer

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Running head: HIGHTOWER MEMORANDUM

Hightower Memo
Student Name
Reg. No
Instructor
Submission Date

1

HIGHTOWER MEMORANDUM

2
Memo
From
To: Hightower management
Date:

Subject: debt acquisition to financing Hightower Company repurchase of stock
Following your request for the financial advice on subject matter concerning debt issuance on
stock valuation and drawing from your resolution attention to obtain debts to be used as an
additional financial source of the Hightower Company to be able to repurchase other stock.
Therefore, the Hightower Company have come to the point of obtaining additional $2 million
debts of a coupon interest rate of 5 %. The memo will indicate all the relevant calculation and
bring various factor such as debt acquisition into the limelight and how they will adjust the
Hightower capital structure and demonstrate various changes occurrence of the business equity
return. Additional, we have included a comprehensive analysis of the changes that occur on the
Hightower balance sheets in case of debt acquisition. In context, various benefit and shortcoming
of the debt financing outlined below. Subsequently, all the solution pertaining the question asked
are well demonstrated hereunder for management to evaluate.
Question 1
The Hightower expected the return on equity obtained from the annual ration calculation aftertax incomes to the company market equity value. Therefore, the Hightower will have to pay the
following amount for each particular year (Hartman, 2000).
𝑡𝑎𝑥𝑒𝑠 = (1,500,000)0.35

HIGHTOWER MEMORANDUM

3
= $525,000

Subsequently the Hightower return on equity (R0) = {

(1500000 − 525,000)
⁄7,500,000}100

𝑅0 = 13 𝑝𝑒𝑟𝑐𝑒𝑛𝑡
Question 2
Before the acq...


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