question archive A consultant working for Evermore Publishing Pty Ltd collates the following financial information about the firm: Total assets:$3,000 million Tax rate:44
A consultant working for Evermore Publishing Pty Ltd collates the following financial information about the firm: Total assets:$3,000 million Tax rate:44
Subject:AccountingPrice:3.86 Bought12
A consultant working for Evermore Publishing Pty Ltd collates the following financial information about the firm:
Total assets:$3,000 million
Tax rate:44.4%
Op. income (EBIT):$800 million
Debt ratio:0%
Interest expense:$0 million
WACC:11.4%
Net income:$480 million
Share price:$32.00
The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends. As a consequence, Evermore's equity value can be calculated by simply dividing earnings by the required return on equity capital, which currently equals the WACC because the company has no debt.
In the financial consultant's professional opinion, the firm would achieve a better equity valuation with negligible financial distress costs if it had a 40 percent debt to 60 percent equity capital structure. To do so, the firm needs to issue $1,200 million of debt at a before-tax cost of 7.0 percent, leaving the company with annual interest expenses of $84.0 million. The $1,200 million debt raised would be used to repurchase stock at $32.00 per share. The repurchase will have no effect on the firm's EBIT.
If the firm follows the consultant's advice, what will be its estimated stock price after the capital structure change? $ (Give answer to 2 decimal places)
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The estimated stock price after the capital structure change is $37.66 per share
Step-by-step explanation
Value of all equity firm
=Net income / WACC
=$480 million / 11.4%
=$4,210,526,316
Number of shares outstanding
=Value of firm / share price
=$4,210,526,316 /32
=131,578,947 shares
Number of shares repurchased at 32
=Amount of debt issued / 32
=$1,200 million / $32
=37,500,000 shares
Number of shares left after issue of debt
=Number of shares outstanding / Number of shares repurchased
=131,578,947-37,500,000
=94,078,947 shares
Value of firm after issue of debt
=Value of Equity + debt*tax rate
=$4,210,526,316 + ($1,200million x 44.4%)
=$4,743,326,316
Value of Equity after repurchase
=Value of firm after issue of debt - Amount of debt issued
=4,743,326,316 - 1,200 million
=$3,543,326,316
Price per share after repurchase
=Value of Equity after repurchase - Number of shares left after issue of debt
=$3,543,326,316 / 94,078,947
=$37.66 per share
Thus, the estimated stock price after the capital structure change is $37.66 per share.
