Question

Newkirk, Inc., is an unlevered firm with expected annual earnings before taxes of $23 million in perpetuity. The current required return on the firm’s equity is 16 percent, and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.5 million shares of common stock outstanding and is subject to a corporate tax rate of 35 percent. The firm is planning a recapitalization under which it will issue $32 million of perpetual 11 percent debt and use the proceeds to buy back shares.

  

a-1.	Calculate the value of the company before the recapitalization plan is announced. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Current value

$

   

a-2.	What is the price per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Price per share

$

  

b-1.	Use the APV method to calculate the company value after the recapitalization plan is announced. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Value after recapitalization

$

  

b-2.	What is the price per share after the recapitalization is announced? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Price per share

$

    

c-1.	How many shares will be repurchased? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Shares repurchased

  

c-2.	What is the price per share after the recapitalization and repurchase? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Price per share

$

   

d.	Use the flow to equity method to calculate the value of the company’s equity after the recapitalization. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Value of the equity

$

Answer 1

a1) Value of equity = EBIT x (1 - tax) / Cost = 23 x (1 - 35%) / 16% = $93,437,500

a2) Price per share = 93,437,500 / 1,500,000 = $62.29

b1) Value after recap = Unlevered value + Debt x tax rate = 93,437,500 + 35% x 32,000,000 = $104,637,500

b2) Price after recap = 104,637,500 / 1.5 = $69.76

c1) No. of shares repurchased = 32,000,000 / 69.76 = 458,716 shares

c2) Price per share = (104,637,500 - 32,000,000) / (1,500,000 - 458,716) = $69.76

d) Dividend per share = (EBIT - Interest) x (1 - tax) / No. of shares

= (23,000,000 - 32,000,000 x 11%) x (1 - 35%) / 1,041,284 = $12.16

New Cost of equity = rs + (rs - rd) x D/E x (1 - tax) = 16% + (16% - 11%) x (1 - 35%) x 32,000,000 / 104,637,500

= $69.76