A company has 10 million shares outstanding, of which management shareholders held 20%. The stock price is $20. It has no debt and faces a tax rate of 30%. There is a Leveraged Recapitalization (LR) proposal that would replace the current stock with stubs - management shareholders to receive N stubs for each share and non-management shareholders to receive 1 stub per share plus a special dividend of $20 per share. This will be financed by an issue of debt. Bankruptcy costs resulting from the debt issue are expected to be $15 million, and the signaling effect of the recap is expected to be 5%. For this LR to be fair to both management and non-management shareholders, what should be the value of N? What is the corresponding value of a stub?
A company has 10 million shares outstanding, of which management shareholders held 20%. The stock price is $20. It has no debt and faces a tax rate of 30%. There is a Leveraged Recapitalization (LR) proposal that would replace the current stock with stubs - management shareholders to receive N stubs for each share and non-management shareholders to receive 1 stub per share plus a special dividend of $20 per share. This will be financed by an issue of debt. Bankruptcy costs resulting from the debt issue are expected to be $15 million, and the signaling effect of the recap is expected to be 5%. For this LR to be fair to both management and non-management shareholders, what should be the value of N? What is the corresponding value of a stub?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:A company has 10 million shares outstanding, of which management shareholders held 20%. The stock price is $20. It
has no debt and faces a tax rate of 30%. There is a Leveraged Recapitalization (LR) proposal that would replace the
current stock with stubs – management shareholders to receive N stubs for each share and non-management
shareholders to receive 1 stub per share plus a special dividend of $20 per share. This will be financed by an issue of
debt. Bankruptcy costs resulting from the debt issue are expected to be $15 million, and the signaling effect of the
recap is expected to be 5%. For this LR to be fair to both management and non-management shareholders, what should
be the value of N? What is the corresponding value of a stub?
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Step 1: Define Leveraged Recapitalization
VIEWStep 2: Computation of the value of the company before the recapitalization:
VIEWStep 3: Computation of the value of the debt issued:
VIEWStep 4: Computation of the value available for equity:
VIEWStep 5: Computation of the special dividend:
VIEWStep 6: Computation of the value of a stub.:
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