Overnight Publishing Company (OPC) has $2.7 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one institution that is willing to sell it back to OPC for $2.7 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all-equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $2.7 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $1,320,000 of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 22 percent and the required rate of return on the firm's unlevered equity is 13 percent. The personal tax rate on interest income is 20 percent and there are no taxes on equity distribution. Assume there are no bankruptcy costs. a. What is the value of OPC if it chooses to retire all of its debt and become an unlevered firm? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) b. What is the value of OPC if it decides to repurchase stock instead of retiring its debt? (Hint. Use the equation for the value of a levered firm with personal tax on interest income from Problem 9 in the textbook.) (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) c. What is the value of OPC if the expected bankruptcy costs have a present value of $525,000? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)
Overnight Publishing Company (OPC) has $2.7 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one institution that is willing to sell it back to OPC for $2.7 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all-equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $2.7 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $1,320,000 of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 22 percent and the required rate of return on the firm's unlevered equity is 13 percent. The personal tax rate on interest income is 20 percent and there are no taxes on equity distribution. Assume there are no bankruptcy costs. a. What is the value of OPC if it chooses to retire all of its debt and become an unlevered firm? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) b. What is the value of OPC if it decides to repurchase stock instead of retiring its debt? (Hint. Use the equation for the value of a levered firm with personal tax on interest income from Problem 9 in the textbook.) (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) c. What is the value of OPC if the expected bankruptcy costs have a present value of $525,000? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)
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
Problem 1PS
Related questions
Question
Transcribed Image Text:Overnight Publishing Company (OPC) has $2.7 million in excess cash. The firm plans to
use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's
debt is held by one institution that is willing to sell it back to OPC for $2.7 million. The
institution will not charge OPC any transaction costs. Once OPC becomes an all-equity
firm, it will remain unlevered forever. If OPC does not retire the debt, the company will
use the $2.7 million in cash to buy back some of its stock on the open market.
Repurchasing stock also has no transaction costs. The company will generate
$1,320,000 of annual earnings before interest and taxes in perpetuity regardless of its
capital structure. The firm immediately pays out all earnings as dividends at the end of
each year. OPC is subject to a corporate tax rate of 22 percent and the required rate of
return on the firm's unlevered equity is 13 percent. The personal tax rate on interest
income is 20 percent and there are no taxes on equity distribution. Assume there are no
bankruptcy costs.
a. What is the value of OPC if it chooses to retire all of its debt and become an
unlevered firm? (Do not round intermediate calculations and enter your answer in
dollars, not millions of dollars, rounded to the nearest whole number, e.g.,
1,234,567.)
b. What is the value of OPC if it decides to repurchase stock instead of retiring its debt?
(Hint. Use the equation for the value of a levered firm with personal tax on interest
income from Problem 9 in the textbook.) (Do not round intermediate calculations
and enter your answer in dollars, not millions of dollars, rounded to the nearest
whole number, e.g., 1,234,567.)
c. What is the value of OPC if the expected bankruptcy costs have a present value of
$525,000? (Do not round intermediate calculations and enter your answer in
dollars, not millions of dollars, rounded to the nearest whole number, e.g.,
1,234,567.)
b.
C.
Answer is complete but not entirely correct.
Company value
Company value
Unlevered value
Levered value
$
5,720,000
5,495,000
5,720,000 X
$
$ 3,675,000
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