Problem:
An all-equity business has 100 million shares outstanding selling for $20 a share. Management believes that interest rates are unreasonably low and decides to execute a dividend recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.
Required:
Question 1: What is the market value of the firm prior to the recap? What is the market value of equity?
Question 2: Assuming the Irrelevance Proposition holds, what is the market value of the firm after the recap? What is the market value of equity?
Question 3: Do equity shareholders appear to have gained or lost as a result of the recap? Please explain.
Question 4: Assume now that the recap increases total firm cash flows, which adds $100 million to the value of the firm. Now what is the market value of the firm? What is the market value of equity?
Question 5: Do equity shareholders appear to have gained or lost as a result of the recap in this revised scenario?
Note: Please provide step by step solution.