Question

The Arden Company has no debt outstanding, and its financial position is given by the following data:

Assets (Market value = book value)	$3,000,000
EBIT	$500,000
Cost of equity, rs	10%
Stock price, Po	$15
Shares outstanding, no	200,000
Tax rate, T (federal-plus-state)	40%

The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 35% debt based on market values, its cost of equity, r_s, will increase to 13% to reflect the increased risk. Bonds can be sold at a cost, r_d, of 7%. Arden is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.

What would be the value of the firm (equity plus debt) after the recapitalization?

	$3,024,193.55
	$3,129,872.22

	$3,000,000
	$3,256,294.11

Answer 1