Reference no: EM132908164

Question -

(1) Two investors have purchased shares of an all-equity firm which has 70,000 shares outstanding at 15 GBP each. A owns shares of a total value of 50,000 GBP and has borrowed 15,000 GBP. B owns shares of a total value of 90,000 GBP and has lent 20,000 GBP. The firm decides to repurchase 25% of its shares by raising perpetual debt at the risk-free rate of 6%. (i) Assume that the first Modigliani - Miller proposition holds and the investor positions are optimal. Find the new positions of the investors. (ii) Consider the alternative case where the firm issues debt and repurchases equity but there is a corporate tax rate of 20%. Is there any change in wealth for the investors and in the value of the firm?

(2) A company has been reliably following a policy of one annual dividend payment of 5$ per share, where all earnings are distributed. The company does not grow and there are 200,000 shares priced at $60. This year, the company decides to use its earnings to repurchase shares instead of issuing a dividend. There are no taxes and no conclusions can be drawn on profitability or business risk from the decision. The number of stocks is rounded at the unit digit. (i) What happens to the stock price immediately after the decision is announced, and how many shares will be repurchased? (ii) Project the stock prices and annual rates of return for stockholders under each policy in the future and discuss your findings. When will the share price exceed $1000 for the repurchase policy? When will the company be left with no shares (rounded to unit) to be repurchased?