Question

Hawar International is a shipping firm with a current share price of

$ 6.50

and

5

million shares outstanding. Suppose Hawar announces plans to lower its corporate taxes by borrowing

$ 20

million and repurchasing shares.

a. With perfect capital​ markets, what will the share price be after this​ announcement?

b. Suppose that Hawar pays a corporate tax rate of

35 %

​,

and that shareholders expect the change in debt to be permanent. If the only imperfection is corporate​ taxes, what will the share price be after this​announcement?

c. Suppose the only imperfections are corporate taxes and financial distress costs. If the share price rises to

$ 7.55

after this​ announcement, what is the PV of financial distress costs Hawar will incur as the result of this new​ debt?

Answer 1

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Answer:

a)

Hawar international announces plans to lower its corporate taxes. SInce this is a transaction, this does not change the share price and will remain at $6.50

b)

= Tax rate*(New shares/old shares) + old share price

Value of shares = 0.35*(20M/5M) + 6.5 = 7.9

c)

New share price - old price * Old shares outstanding

PV of distress costs = ( 7.9 - 7.55) * 5M

= 1,750,000