Assume that you are CEO of a firm that is currently worth 200 million dollars an
ID: 2716555 • Letter: A
Question
Assume that you are CEO of a firm that is currently worth 200 million dollars and has no debt in its capital structure. There are 10 million shareholders, thus, each share is worth 20 dollars per share. You have decided to issue 100 million dollars in debt and use the proceeds to buy back shares of stock. The debt will have a coupon rate of 7.5 percent, the corporate tax rate is 35 percent, and interest payments are tax-deductible. If there are no costs of financial distress to worry about or transactions costs incurred in the process of issuing debt and buying back shares, what should be the price per share of the remaining shares once you are done with the buyback?Explanation / Answer
Buy Back of Share = 100 Million/20 = 5 Million
Outstanding Share after Buy Back = 10-5
Outstanding Share after Buy Back = 5 Million
Value of Unlevered Firm = $ 200 Million
Value of Levered Firm = Value of Unlevered Firm + Debt*tax rate
Value of Levered Firm = 200 + 100*35%
Value of Levered Firm = $ 235 Million
Value of Equity after Buy back = Value of Levered Firm - Debt
Value of Equity after Buy back = 235-100
Value of Equity after Buy back = $ 135 Million
Price per share of remaining Share = Value of Equity after Buy back/Outstanding Share after Buy Back
Price per share of remaining Share = 135/5
Price per share of remaining Share = $ 27