Question

Rockwood Industries has 100 million shares outstanding, a current share price of $25, and no debt. Rockwood's management believes that the shares are under-priced, and that the true value is $30 per share. Rockwood plans to pay $250 million in cash to its shareholders by repurchasing shares. Management expects that very soon new information will come out that will cause investors to revise their opinion of the firm and agree with Rockwood's assessment of the firm's true value.

40. Assume that Rockwood is able to repurchase shares prior to the market becoming aware of the new information regarding Rockwood's true value. After the repurchase, and following the release of the new information regarding the true value of Rockwood, the firm's share price is closest to:

A. $30.00

B. $31.50

C. 28.75

D. $30.60

41. Assume that Rockwood is not able to repurchase shares prior to the market becoming aware of new information regarding Rockwood's true value. After the release of the new information regarding the true value of Rockwood, and following the repurchase, the firm's share price is closest to:

A. $30.00

B. $30.60

C. $28.75

D. $31.50

Answer 1

1) Company value = true value*number of shares outstanding = 100*30 = 3000 million

number of shares after repurchase = 100 - cash used/current price = 100-250/25 = 90 mln

Company value after repurchase = Company value before * cash used for repurchase = 3000 -250 = 2750 mln

Price after repurchase = company value/share outstanding = 2750/90 = 30.6

2)

Company value = true value*number of shares outstanding = 100*30 = 3000 million

number of shares after repurchase = 100 - cash used/current price = 100-250/30 = 91.66 mln

Company value after repurchase = Company value before * cash used for repurchase = 3000 -250 = 2750 mln

Price after repurchase = company value/share outstanding = 2750/91.666 = 30