Question

Suppose a Company’s value of operations is equal to $900 million after a recapitalization (the firm had no debt before the recapitalization). It raised $300 million in new debt and used this debt to buy back stock. The Company had no short-term investments before or after the recap. After the recap, wd=1/3. The firm had 30 million shares before the recap. What is P (the stock price after the recap)?        

Answer 1

Answer :

Calculation of P (the stock price after the recap) :

Weight of debt after recap = 1/3 = $300 million

So, the weight of equity = ( 1 - 1/3 ) = 2/3 = $600 million

Share price before recap = $900 million / 30 million = $30

No. of shares bought back with the proceeds of new debt = $300 million / $30 = 10 million

No. of shares outstanding after buyback = 30 million - 10 million = 20 million

Stock price after recap = Weight of equity after recap / No. of shares outstanding after buyback

= $600 million / 20 million

Therefore,

The stock price after recap = $30