Question

Kurz Manufacturing is currently an​ all-equity firm with 22 million shares outstanding and a stock price of $8.00 per share. Although investors currently expect Kurz to remain an​ all-equity firm, Kurz plans to announce that it will borrow $47 million and use the funds to repurchase shares. Kurz will pay interest only on this​ debt, and it has no further plans to increase or decrease the amount of debt. Kurz is subject to a 35% corporate tax rate.  

a. What is the market value of​ Kurz's existing assets before the​ announcement?

b. What is the market value of​ Kurz's assets​ (including any tax​ shields) just after the debt is​ issued, but before the shares are​ repurchased?

c. What is​ Kurz's share price just before the share​ repurchase? How many shares will Kurz​ repurchase?

d. What are​ Kurz's market value balance​ sheet, and share price after the share​ repurchase?

Answer 1

a. Existing assets = Current price per share * Number of outstanding share

= $8.00 * 22 million

= $176 million

b. Market value = Existing assets + Cash + Tax shield

= $176 million + $47 million + (0.35 * $47 million)

= $176 million + $47 million + $16.45 million

= $239.45 million

c. Equity = Market value - Debt

= $239.45 - $47 million

= $192.45 million

Share price = Equity/ No. of outstanding share

= $192.45 million / 22 million

= $8.747 per share

Repurchase = Debt / Share price

= $47 million / $8.747

= $5.373 million

d. Market value balance sheet = Existing assets + Tax shield

= $176 million + (0.35 * $47 million)

= $176 million + $16.45 million

= $192.45 million

Equity value = Market value - Debt

= $192.45 million - $47 million

= $145.45 million

Share price after repurchase = Equity value / (Outstanding share - Share repurchase)

= $145.45 million / ($22 million - $5.373 million)

= $145.45 million / $16.627 million

= $8.747 per share