A firm has a current debt/equity ratio of 2:3. It is worth $10 billion, of which $4 billion is debt. The firm's overall cost of capital is 12%, and its debt currently pays an (expected) interest rate of 5%.
The firm estimates that its debt rating would deteriorate if it were to refinance to a 1:1 debt/equity ratio through a debt-for-equity exchange, so it would have to pay an expected interest rate of 5.5%.
The firm is solidly in a 35% corporate income tax bracket. The firm reported net income of $500 million.
On a corporate income tax basis only, ignoring all other capital structure-related effects, what would you estimate the value consequences for this firm to be? When would equity holders reap this benefit? What would be the stock's announcement price reaction?