Problem:
An all-equity firm is subject to a 30% tax rate. Its total market value is initially $3,500,000, and there and 175,000 shares outstanding. The firm announces a program to issue $1 million worth of bonds at 10% interest and to use the proceeds to buy back common stock.
Required:
Question 1: What is the value of the tax shield that the firm acquires through the bond issue?
Question 2: According to M&M, what is the likely increase in market value per share of the firm after the announcement (assuming efficient markets)?
Question 3: How many shares will the company be able to repurchase?
Explain in detail and show all workings.