Firen, Inc. is an all-equity firm that has 500,000 shares of stock
outstanding. The company has decided to borrow $8 million at 9% interest to repurchase 200,000 shares of outstanding stock.
a. Suppose that Firen operates without taxation (or financial distress). What is the value of this firm in its current all-equity state. What will the firm’s value be after the recapitalization?
b. Under MMI, in a world with no taxes (nor financial distress), would the value of the levered firm above (i.e. Firen with $8 million of debt after the recapitalization) increase or decrease if only $4 million was borrowed to buy back 100,000 shares of stock? Explain your answer.
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