The NEWT Company is located in a country where there are no taxes and there are
ID: 2723009 • Letter: T
Question
The NEWT Company is located in a country
where there are no taxes and there are
perfect capital markets so that there are no bankruptcy costs. The corporation currently
has $25 million in debt outstanding and the value of its equity is $75 million. The return
on its equity is 15% and the return o
n its debt which is currently risk free is 8%. Suppose
NEWT decides to issue $15 million additional debt and use it to repurchase $15 million
of equity. The new debt is expected to be risk free after the issue. All the debt, both
before and after the refin
ancing, consists of perpetuities.
(a) What is the total value of the firm after the refinancing?
(b) What would the return on the equity be after the refinancing
Explanation / Answer
Answer to Part (a) Total Value of the firm after refinancing = MArket value of debt + Market value of Equity
Market value of Debt after refinancing = 25 million + 15 million = 40 Million
Markt value of Equity after refinancing = 75 million - 15 million = 60 million
Total Value of firm after refinancing = 40 miilion + 60 million = $ 100 million
Answer to Part (b) Return of Equity after refinancing :
Value of Equity after refinanncing = 60 Million
Return on Equity= 15%
Return on Equity after refinancing = 15% on 60 million = 9 million