Topshop plc is planning to repurchase part of its ordinary share equity by issuing corporate debt. As a result, the firm’s debt-equity ratio is expected to rise from 30% to 40%. The firm currently has £1,200,000 worth of debt outstanding. The cost of this debt is 8% per year. Topshop expects to have an earnings before interest and tax (EBIT) of £655,000 per year in perpetuity. Topshop pays no taxes.
(a) What is the market value of Topshop plc before and after the repurchase announcement?
(b) What is the expected return on Topshop’s equity before the announcement of the share repurchase plan?
(c) What is the expected return on the equity of an otherwise identical all-equity firm?
(d) What is the expected return on Topshop’s equity after the announcement of the share repurchase plan?
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