Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Chapter 18, Problem 21P

DFS Corporation is currently an all-equity firm, with assets with a market value of $100 million and 4 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 35% 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 5% of the amount of debt raised. Adding leverage will also create the possibility of future financial distress or agency costs; shown below are DFS’s estimates for different levels of debt:

Chapter 18, Problem 21P, DFS Corporation is currently an all-equity firm, with assets with a market value of 100 million and

  1. a. Based on this information, which level of debt is the best choice for DFS?
  2. b. Estimate the stock price once this transaction is announced.
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