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An all-equity business has 100 million shares outstanding selling for $20 a share. Management believes that interest rates are unreasonable low and decides to execute a leveraged recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.
a. What is the market value of the firm prior to the recap? What is the market value of equity?
b. Assuming the Irrelevance Proposition holds, what is the market value of the firm after the recap? What is the market value of equity?
c. Do equity shareholders appear to have gained or lost as a result of the recap? Please explain.
d. Assume now that the recap increases total firm cash flows, which adds $100 million to the value of the firm. Now what is the market value of the firm? What is the market value of equity?
e. Do equity shareholders appear to have gained or lost as a result of the recap in this revised scenario?
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Richard, age 40, is the owner of Auto Repair, Inc. In addition to Richard, the company has five employees. Richard wants to establish a retirement plan for his employees. Explain to Richard the advantages and disadvantages of each plan. Susan, age 28..
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