Marpor Industries has no debt and expects to generate ?16 million in earnings before interest and taxes in perpetuity. Marpor has 10 million shares outstanding. Marpor plans to borrow ?20 million on a permanent basis and use these funds to repurchase shares. The treasurer estimates that the equity beta of the firm is currently 1.1. Assume that the risk free interest is 5% per year, and the expected return of the market is 15% per year. Marpor pays corporate tax of 35% per year.
(a) Estimate Marpor's value without leverage.
(b) Estimate Marpor's value with the new leverage. What will Marpor's share price be after the change of capital structure? How many shares will remain outstanding after the repurchase?
(c)Briefly explain the market reaction of issuing debt.
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