We are in the MM world. For simplicity all cash flows are assumed to be perpetuity. Recall that a perpetual bond is a bond with indefinite maturity (N=?). Use perpetuity concept to evaluate a perpetual bond. Before the Announcement Hamster Inc. is a levered firm with publicly listed shares. The firm has equity and debt but no other liabilities outstanding. The company has 250m shares outstanding with a share price of $16, an estimated equity beta of 1.075 and an expected return (Rs) of 10.6%. The firm has 1 million Serial A bond outstanding with $1,000 face value, 6% annual coupon and 6% yield to maturity. Given the portfolio of assets currently managed by the firm, a stream of perpetual EBIT in the amount of $766.67 million per annum is expected. The corporate income tax rate (Tc) is 40 percent. Risk free rate is 2% and the expected return on the market portfolio is 10%.
1) Find Hamster’s market value. {Hint: This is easier than it seems. There is a straightforward way to calculate it.}
2) Use the APV method to estimate Vu. {Requirement: The APV method requires an estimation of Ro. Using other methods to solve this problem will result in severe penalty.} (20 points) The Announcement Hamster Inc. announces that it will issue 0.25m Serial B bond with $1,000 face value, 6% annual coupon and 6% yield to maturity. The firm will use the funds to retire existing equity. Therefore, this is a debt-equity transaction that increases the firm’s leverage.
3) Determine how this leverage-increasing transaction will affect shareholder value. Calculate it.{Hint: Use MM theory.}