2017 S1 FINA2222 CFPJOEY YANGPage 3 QUESTIONSCapital structure1.With the help of the Excel spread sheet provided, compute the market debt to equity (D/E) ratio for HDC. Then use it to compute the current cost of equity (rE) and the pretax-WACC for HDC. Assuming the cost of unlevered equity (rU) is 12%. (Hint: the market value of debt equals its book value; it is the sum of Long-Term Debt and Short-Term Debt.)At present Kyle is considering the following share repurchase proposal from the firm’s CFO: the company could raise $5 billion new debt (on permanent basis) at a competitive rate of 0.58% to repurchase shares.2.Compute the market D/E ratio, rE and pretax-WACC in this scenario.3.Compare your results in Questions 1 and 2. Explain the relationship between capital structure and the cost of capital with no taxes (as if in perfect markets). How would the weight average cost of capital (WACC) differ if the effect of taxes is incorporated? Justify.Assume that Kyle was impressed by your discussion in Question
3. He now understands that interest is tax deductable and the firm could potentially benefit from issuing more debt. Kyle decides to issue $5 billion of debt (on permanent basis) and use the proceeds to repurchase shares.
4.What is the present value of interest tax shield (ITS) of the new debt?
5.At the announcement of the repurchase, what is the new market value of the equity and theshare price (assume no arbitraging)?
6.After the repurchase, how many shares are outstanding? How has this deal affected the total value of the firm?Payout policy
7.If HDC adopts a 100% dividend payout policy, what is the after-tax dividend income of a shareholder whose personal tax rate is 36%, in 1) a classic tax system; and 2) the imputation tax system? Which tax system would he/she favour? Why?
