Question

1. Smith Industries is an industrial company with 110 million shares outstanding and a market capitalization​ (equity value) of $5.65 billion. It has $2.32 billion of debt outstanding. Management has decided to de-lever the firm by issuing new equity to repay all outstanding debt.

   1. How many new shares must the firm​ issue?

   2. Suppose you are a shareholder holding 100​ shares, and you disagree with this decision. Assuming a perfect capital​ market, describe what you can do to undo the effect of this decision.

Answer 1

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Answer:

a. Share price = 5.65b/110m = $51.364, Issue 2.32b/40 = 45.168 million shares

b. You can undo the effect of the decision by borrowing to buy additional shares, in the same proportion as the firm’s actions, thus

relevering your own portfolio. In this case you should buy (45.168 million/ 110 million)*100 = 41 new shares and borrow (41~*51.364) = $2109