Seger, Inc., is an unlevered firm with expected annual earnings before taxes of $30 million in perpetuity. The current required return on the firm's equity is 20 percent, and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.5 million shares of common stock outstanding and is subject to a corporate tax rate of 30 percent. The firm is planning a recapitalization under which it will issue $35 million of perpetual 8 percent debt and use the proceeds to buy back shares.
Requirement 1:
Calculate the value of the company before the recapitalization plan is announced. What is the value of equity before the announcement? What is the price per share?
Value of equity $ ___________
Price per share $ ___________
Requirement 2:
Use the APV method to calculate the company value after the recapitalization plan is announced. What is the value of equity after the announcement? What is the price per share?
Value of equity $ ___________
New share price $ ___________
Requirement 3:
How many shares will be repurchased? What is the value of equity after the repurchase has been completed? What is the price per share?
Shares repurchased __________
Value of equity $
New share price $
Requirement 4:
Use the flow to equity method to calculate the value of the company's equity after the recapitalization.
Value of equity $ ____________