Corporate Finance- Effect of Debt Issuance on Stock Valuation

Scenario: Hightower, Inc. plans to announce it will issue $2.0 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 5%. Hightower, Inc. is currently an all-equity company worth $7.5 million with 400,000 shares of common stock outstanding. After the sale of the bonds, the company will maintain the new capital structure indefinitely. The company currently generates annual pretax earnings of $1.5 million. This level of earnings is expected to remain constant in perpetuity. The tax rate is 35%.

Answer the following questions. Show calculations in Excel and then give a full explanation in a word document.

1. How many shares will the company repurchase as a result of the debt issue? How many shares of common stock will remain after the repurchase?
2. What is the required return on the company’s equity after the restructuring?