Need help with paper/memo: Effect of Debt Issuance on Stock Valuation
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Note from me: Please write at least 500 words, as I will not use any material I do not truly understand. Please include Excel calculations within the memo paper as well as attach excel doc so I can see the formulas used and how the calculations were achieved (I want to learn no just get answers). Please use good sources I can easily get to on the internet (just not word for word quotes from sites like Investopedia), citing references within the paper itself as well as in reference page at end of paper. Course text book mentioned is also a great reference to use. This is part of a group project and the three bullets mentioned below is my portion. There are five others for the rest of the group but I did not include those.
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.
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 500+ 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.
Show all calculations and submit with your memo.
Format your paper consistent with APA guidelines.