Question

An all-equity business has 135 million shares outstanding selling for $20 a share. Management believes that interest rates are unreasonably low and decides to execute a leveraged recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares. a. What is the market value of the firm prior to the recap? What is the market value

An all-equity business has 135 million shares outstanding selling for $20 a share. Management believes that interest rates are unreasonably low and decides to execute a leveraged recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.

a. What is the market value of the firm prior to the recap? What is the market value of equity? (Enter your answers in billions rounded to 1 decimal place.)

Answer 1

The market value of the firm prior to the leveraged recapitalization is $2.7 billion, which is calculated by multiplying 135 million shares by the share price of $20. The market value of equity is also $2.7 billion, as the firm is all-equity before the recapitalization.

Step-by-step explanation:

The market value of an all-equity business prior to a leveraged recapitalization can be determined by multiplying the number of shares outstanding by the price per share. In this scenario, there are 135 million shares outstanding, and each share is selling for $20. Thus, the market value of the firm prior to the recap is:

• 135 million shares × $20/share = $2.7 billion

The market value of equity is the same as the market value of the firm when the firm is all-equity. Therefore, prior to the leveraged recapitalization, the market value of equity is also $2.7 billion.

After the recap, the firm raises $1 billion in debt and repurchases 50 million shares. However, this action doesn't change the initial market value of the firm, it just changes the structure of the firm's finances by replacing a portion of equity with debt.