Question

Consider ABC Co. with the following balance sheets. The firm decides to borrow $500 mil more on a permanent basis, and use the proceeds to repurchase shares. Assume T_C=30%, and that the stock price before the change is $70 per share.

B/S (BV)			B/S (MV)
NWC   400	L-T Debt 200		NWC   400	L-T Debt 200
FA       600	Equity      800		FA       1200	Equity      1400
1000	1000		1600	1600

a) What is the present value of all the tax savings in the future? Assume the firm's debt ($500 m) is permanent and the tax rate also stays the same (tC=30%).

b)  What is the total market value of the firm's assets after the firm adds $500 million debt to repurchase shares?

c) What is the total market value of the firm's equity after the firm adds $500 million debt to repurchase shares?

d) At what price should the firm repurchase the stock per share?

Answer 1

a) PV of Tax savings in future = Debt * Tax rate = 500 * 30% = 150 million
b) Market Value of firms assets after taking 500 million debt = Total Maket value of capital + PV of tax savings = 1600 + 150 = 1750 million
c) Market Value of Firms equity after the repurchase = Equity - new debt +PV of Tax shield = 1400 -500 + 150 = 900 + 150 = 1050
d)No of Shares = Market value of Equity/ Current Price per share = 1400/70 = 20
Price per share at which firm should repurchase =(Market Value of Equity + Pv tax shield)/No of Shares = (1400 + 150) /20 = 1550/20 = 77.50 per share

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