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Ace Manufacturing is an all-equity financed firm with a current market value of $500 million and 10 million shares outstanding. Ace plans to announce that it will issue $100 million of perpetual bonds and use these funds to repurchase equity. The bonds will have a 6-percent coupon rate. After the sale of the bonds and the share repurchase, Ace will maintain the new capital structure indefinitely. The corporate tax rate for Ace is 35%, and there are no personal taxes.
Problem a) Immediately after Ace announces its plan to issue bonds and repurchase equity, what will the market value of its equity be? What will its stock price be?
Problem b) How many shares will Ace repurchase?
Problem c) After the bond issue and share repurchase are completed, what will be the market value of Ace's equity?
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