Answer Happy

Question 3. Northrop has 80 million shares worth $10 per share and no debt. Its cost of capital is 5%. It has a perpetual random CF with mean $40 million and it pays no taxes. Northrop plans a leveraged recapitalization, in which it will issue $300 million in perpetual debt at an interest rate of 2% per year and use the proceeds to repurchase shares. The firm operates in the Modigliani-Miller world with no taxes. a) What are Northrop's firm value, cost of equity, and WACC before the recapitalization? b) What are Northrop's firm value, equity value, debt value, cost of equity, and WACC after the recapitalization? Compare you results to those in a) and interpret the differences. c) What happens with Northrop's equity values and share price at the time of the announcement but before the recapitalization is executed? d) How many shares can Northrop repurchase and how many shares outstanding are left after the transaction?