Question

The process of recapitalization Recapitalization is the process through which firms make desired changes in their capital structure by using debt capital to repurchase outstanding equity. Firms use a recap for several reasons: to achieve or maintain the firm's optimal capital structure, to defend against a hostile takeover, to minimize taxes, or as an exit strategy for venture capitalists. As an analyst, you are tracking the financial performance of Merry Meerkat Manufacturing Company. The company has been 100\% equity owned for years, but recently the firm's managers made changes to Merry Meerkat's capital structure. You have collected the following information regarding the company's recapitalization: - Merry Meerkat issued $2,000,000 in new debt to repurchase its outstanding stock. - The firm had no short-term investments before or after the recapitalization. - Merry Meerkat had 250,000 shares outstanding before the recapitalization. - Merry Meerkat's capital structure now has 20.00% debt. - The company's operations are valued at $10,000,000 before and after the recapitalization. Based on the information available, solve for the values in the following table. Click on the dropdown menus and select the best answer. Assume that you are in a Modigliani and Miller (MM Proposition I) world with no taxes. ferences. While proofreading, you come across the following inference: If Merry Meerkat Manufacturing Company decides to deleverage in the future, the total number of shares outstanding will keep decreasing until creditors own 100% of the company. Is the statement true or false? True False

Answer 1

The assertion regarding Merry Meerkat Manufacturing Company's deleveraging and the consequent ownership shift to creditors owning 100% is false. Deleveraging involves repaying debt, which does not directly affect share counts unless new equity is issued. Additionally, in an MM Proposition I world, the firm's value is not influenced by capital structure changes.

Step-by-step explanation:

The statement that Merry Meerkat Manufacturing Company's total number of shares outstanding will keep decreasing until creditors own 100% of the company if it decides to deleverage in the future is false. Deleveraging means reducing debt, which could involve repaying debt, possibly using cash on hand or by raising funds through issuing new equity. Simply put, deleveraging would generally involve reducing liabilities on the balance sheet, not necessarily altering the number of shares outstanding unless new equity is issued.

Merry Meerkat's potential deleveraging would not automatically result in creditors owning 100% of the company. Under Modigliani and Miller Proposition I, without taxes and in a perfect market, the value of the firm is unaffected by changes in the capital structure. Therefore, the share count and ownership would only change if the company specifically issues new shares or buys back existing shares as part of its capital restructuring efforts.