Kurz Manufacturing is currently a levered firm with 50M shares outstanding priced at $10.00 per share and 250K bonds outstanding priced at $1,000 per bond (this is also the face value of each bond). Investors expect these bonds to pay interest of 4 percent per year and this debt level to be held in perpetuity. Assume that Kurz is subject to a 25 percent corporate tax rate.
a) What is the market value of Kurz’s existing assets?
b) The value of Kurz’s assets consists of the value of operating assets and the value of the tax shield. What is the value of the tax shield and operating assets?
Kurz announces that tomorrow it will issue $100M worth of shares and use those funds to retire $100M worth of debt. Assume that the market did not expect this announcement.
c) What is the new price per share immediately following this announcement, but before the shares are issued or the debt is retired? (hint: the share price will decrease because of a change in the value of the tax shield)
d) What percentage of the firm’s equity does Kurz have to sell to rise $100M?