Question

An all-equity business has 170 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?

Answer 1

The market value of the firm prior to the leveraged recapitalization is $3.4 billion. Since the company is an all-equity business, the market value of equity is also $3.4 billion.

Step-by-step explanation:

Market Value of the Firm Prior to Recapitalization

To calculate the market value of the firm prior to the leveraged recapitalization (recap), we need to multiply the number of shares outstanding by the current share price. The firm has 170 million shares outstanding selling at $20 each.

Market Value of the Firm = Number of Shares Outstanding × Share Price

Market Value of the Firm = 170 million × $20

Market Value of the Firm = $3.4 billion

Market Value of Equity

The market value of equity is identical to the market value of the firm in this case, as it is an all-equity business without any debt. Therefore, the market value of equity is also $3.4 billion.

Note that the provided reference information does not directly relate to this specific question, hence it wasn't used in the calculation.