Amish Electronics Inc.is all equity financed and generates perpetual annual EBIT of $600.Assume that the EBIT,and all other cash flows,occur at year end and that we are currently at the beginning of a year.Assume that Amish has a 100% payout rate,5,000 shares outstanding,and that shareholders require a return of 5%.Assume that the tax rate is 0%.
Amish is considering an open market stock repurchase.It plans to buy 20% of its outstanding shares at the price of $4.00 per share.The repurchased shares will be cancelled.It will finance the repurchase by issuing perpetual bonds with a coupon rate (and yield)of 3%.Assume that the tax rate is 0%.
If Amish goes ahead with the repurchase,then what is the value of the company after the repurchase is complete?
A) $4,800
B) $6,000
C) $7,200
D) $10,000
E) $12,000

Question

Quizplus · Accepted Answer

According to M&M Proposition I, the value of the levered firm is equal to the unlevered firm. V_U = V_L Since the value of the unlevered firm is: V_U = 11ea7fdb_fc60_a9a4_a768_654419a0e5a1_TB2902_11 = 11ea7fdb_fc60_a9a5_a768_f933182f220e_TB2902_11 = $12,000 V_L = $12,000