The Hifalutin Co

Multiple Choice

The Hifalutin Co. has perpetual EBIT of $3,000. It has no debt in its capital structure, and its cost of equity is 15%. The corporate tax rate is 40%. There are 300 shares outstanding. Hifalutin has announced that it will borrow $3,750 in perpetual debt at 8% and use the proceeds to buy up stock. A firm is all equity with 5,000 shares outstanding worth $7 each. They are planning on issuing $10,000 of new perpetual debt at the 8% market rate of interest. The effective tax rate is 25%. What is the change in equity value if they make the debt for equity exchange?

A) $.50 per share
B) $200
C) $800
D) $.16 per share