An unlevered firm has a perpetual EBIT = $1500. The current value of the firm is Vu = $1500. The share count of the firm is N0 = 1000. The firm considers repurchasing its shares by issuing debt. It plans to issue a risk-free, perpetual debt such that the D/E ratio after the recap is D/E = 1/3. Corporate tax rate is t = 25%, and the cost of debt, Rf = 5%. Assume tax is the only imperfection.
a) What is the value of the firm after the recap? Draw the market value balance sheet of the transaction.
b) How many shares are repurchased?
c) What are the cost of equity (Re), weighted average cost of capital (WACC), and PE ratio after the recap?