Please no EXCEL sheets and please show work for everything! 5. Suppose ABC Inc. has...
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Please no EXCEL sheets and please show work for everything!
5. Suppose ABC Inc. has earnings of 6 millions in 2022. Its cost of capital is 20%. ABC Inc. never borrowed money from any bank or from the public. Now, the CEO of the company heard that debt has some tax advantage and he knew that ABC Inc. paid a lot of taxes to the government each year. So, he is thinking about issuing 5 million debt and using the proceeds to buy back shares in the market. The before-tax cost of debt is 10%. Help him to make the decision by answering the following questions. Analyze this by assuming no personal taxes and a flat corporate tax rate of 35%.
a. Whats the market value of ABC Inc. before issuing debt?
b. Whats the market value of ABC Inc. after issuing debt?
c. After issuing debt, whats the market value of equity and stock price? Whats the stock price before issuing debt? (Assume ABC Inc. initially has 325,000 shares outstanding.) Is there any difference of stock prices before and after debt issuance? Why?
d. Whats the cost of equity for ABC Inc. after issuing debt?
e. Whats the weighted average cost of capital for ABC Inc. if 5 million debt is issued?
f. What would you recommend to him? Issue or not issue debt?
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