Cerberus Security Company produces a cash flow of $160 per year and is expected to continue doing so in the infinite future. The cost of equity capital for Cerberus is 22 percent, and the firm is financed entirely with equity. Management would like to repurchase $100 in shares by borrowing $100 at a 8 percent rate (assume that the debt will also be outstanding into the infinite future). Using Modigliani and Miller’s Proposition 1 answer the following questions.
What is the value of the firm today?
What will be the value of the claims on the firm’s assets after the stock repurchase?
What will be the rate of return on common stock required by investors after the share repurchase?