DFS Corporation is currently an all-equity firm, with assets with a market value of $102 million and 3 million shares outstanding. DFS is considering a leveraged recapitalization to boost its share price. The firm plans to raise a fixed amount of permanent debt (i.e., the outstanding principal will remain constant) and use the proceeds to repurchase shares. DFS pays a 22% corporate tax rate, so one motivation for taking on the debt is to reduce the firm's tax liability. However, the upfront investment banking fees associated with the recapitalization will be 3% of the amount of debt raised. Adding leverage will also create the possibility of future financial distress or agency costs; shown in the table here,, are DFS's estimates for different levels of debt. a. Based on this information, which level of debt is the best choice for DFS? b. Estimate the stock price once this transaction is announced. Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Debt amount ($ million) Present value of expected distress and agency costs ($ million) 0 ** 0.0 10 -0.73 20 - 1.92 30 -3.55 40 -7.72 50 - 12.23

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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DFS Corporation is currently an all-equity firm, with assets with a market value of $102 million and 3 million shares
outstanding. DFS is considering a leveraged recapitalization to boost its share price. The firm plans to raise a fixed
amount of permanent debt (i.e., the outstanding principal will remain constant) and use the proceeds to repurchase
shares. DFS pays a 22% corporate tax rate, so one motivation for taking on the debt is to reduce the firm's tax
liability. However, the upfront investment banking fees associated with the recapitalization will be 3% of the amount of
debt raised. Adding leverage will also create the possibility of future financial distress or agency costs; shown in the
table here, are DFS's estimates for different levels of debt.
.
a. Based on this information, which level of debt is the best choice for DFS?
b. Estimate the stock price once this transaction is announced.
Data table
(Click on the following icon in order to copy its contents into a spreadsheet.)
Debt amount ($ million)
0
Present value of expected distress
and agency costs ($ million)
0.0
10
-0.73
20
- 1.92
30
-3.55
40
-7.72
50
- 12.23
I
Transcribed Image Text:DFS Corporation is currently an all-equity firm, with assets with a market value of $102 million and 3 million shares outstanding. DFS is considering a leveraged recapitalization to boost its share price. The firm plans to raise a fixed amount of permanent debt (i.e., the outstanding principal will remain constant) and use the proceeds to repurchase shares. DFS pays a 22% corporate tax rate, so one motivation for taking on the debt is to reduce the firm's tax liability. However, the upfront investment banking fees associated with the recapitalization will be 3% of the amount of debt raised. Adding leverage will also create the possibility of future financial distress or agency costs; shown in the table here, are DFS's estimates for different levels of debt. . a. Based on this information, which level of debt is the best choice for DFS? b. Estimate the stock price once this transaction is announced. Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Debt amount ($ million) 0 Present value of expected distress and agency costs ($ million) 0.0 10 -0.73 20 - 1.92 30 -3.55 40 -7.72 50 - 12.23 I
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