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An all-equity firm is subject to a 30% tax rate. Its total market value is initially $3,500,000, and there and 175,000 shares outstanding. The firm announces a program to issue $1 million worth of bonds at 10% interest and to use the proceeds to buy back common stock.
a. What is the value of the tax shield that the firm acquires through the bond issue?
b. According to M&M, what is the likely increase in market value per share of the firm after the announcement (assuming efficient markets)?
c. How many shares will the company be able to repurchase?
What is the effect of stock (not cash) dividends and stock splits on the market price of common stock? Why do corporations declare stock splits and stock dividends?
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