II. Recap (8 points) An all-equity business has 100 million shares outstanding s
ID: 2795092 • Letter: I
Question
II. Recap (8 points) An all-equity business has 100 million shares outstanding selling for $25 a share. Management believes that interest rates are unreasonably low and decides to execute a leveraged recapitalization (a recap). It will raise $1.0 billion in debt and repurchase 40 million shares. a. What is the market value of the firm prior to the recap? b. What is the market value of equity? c. Assuming the irrelevance proposition holds, what is the market value of the firm after the recap? d. What is the market value of equity after the recap?Explanation / Answer
a)
Market Value Prior to the recap = 100 M * 25 = $ 2,500 M
b)
Market Value of Equity = Market Value of firm (since it is an all equity firm) = $ 2500 M or $2.5 B
c)
After the recap,
With $ 1 billion of debt, amount of equity repurchased = 1000 M/25 = 40 M shares
So Outstanding shares now = 100-40 = 60 M shares
MV of Equity = 60* 25 = 1500 M
MV of debt = 1000M
Total MV of firm =1500+1000= $ 2500 M
d)
MV of Equity = $ 1500 M