Hawar International is a shipping firm with a current share price of $5.50 and 10 million shares outstanding. Suppose Hawar announces plans to lower its corporate taxes by borrowing $20 million and repurchasing shares.

a) With perfect capital markets, what will the share price be after this announcement?

Suppose that Hawar pays a corporate tax rate of 30%, and that shareholders expect the change in debt to be permanent.

b) If the only imperfection is corporate tax rate of 30%, what will the share price be after this announcement?

c) Suppose the only imperfections are corporate taxes and financial distress costs. If the share price rises to $5.75 after this announcement, what is the PV of financial distress costs Hawar will incur as the result of this new debt?

a. From the question, we are informed that Hawar International is a shipping firm with a current share price of $5.50 and 10 million shares outstanding and that Hawar announces plans to lower its corporate taxes by borrowing $20 million and repurchasing shares.

We are informed that Hawar announces plans to lower its corporate taxes by borrowing $20 million and repurchasing shares. This is a transaction and therefore, the value if the share won't be changed. So, the value for the share will still be $5.50.

b. If the only imperfection is corporate tax rate of 30%, the share price after this announcement will be:

= [30% × (20million/10million)] + $5.50

= [0.3 × 2] + $5.50

= $0.6 + $5.50

= $6.1

Therefore, the share price be after this announcement will be $6.1.

c. If the share price rises to $5.75 after this announcement, the PV of financial distress costs Hawar will incur as the result of this new debt will be:

= ($6.1 - $5.75) × 10,000,000

= $0.35 × 10,000,000

= $3,500,000

anthougo anthougo · Answer 2 · 2022-02-17T14:06:16+01:00

a) With perfect capital markets, the share price of Hawar International, after this announcement will remain at $5.50 per share.

b. If the only imperfection in the capital market is caused by the corporate tax rate of 30%, the share price after this announcement will be $6.10.

c. If the share price increases to $5.75 after this announcement, the PV of financial distress costs that Hawar will incur from the new debt is $3,500,000.

What are the financial distress costs?

The financial distress costs are the additional expenses that a firm in financial distress faces as a result of higher cost of capital with debts instead of equity funds.

Data and Calculations:

Current share price = $5.50

Outstanding shares = 10 million

Proposed loan for share repurchase = $20 million

Corporate tax rate = 30%

b. This new share price is computed as current share price + (Debt/Equity x 30%).

= $6.10 {$5.50 + ($20/$10 x 30%)}

c. The financial distress costs = $3,500,000 {10,000,000 x ($6.1 - $5.75)}

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