Question

d'Anconia Copper is an all-equity firm with 60 million shares outstanding, which are currently trading at $20 per share. Last month, d'Anconia announced that it will change its capital structure by issuing $200 million in debt. The $200 million raised by this issue, plus another $200 million in cash that d'Anconia already has, will be used to repurchase existing shares of stock. Assume that capital markets are perfect. Suppose you are a shareholder in d'Anconia Copper holding 500 shares, and you disagree with the decision to lever the firm. You can undo the effect of this decision by _________.

• A. borrowing $2000 and buying 100 shares of stock
• B. selling 60 shares of stock and lending $1200
• C. selling 100 shares of stock and lending $2500
• D. borrowing $1200 and buying 60 shares of stock

Answer 1

Shares that will be Bought back = Total Cash available/Share Price = 400 million/20 = 20 million shares

Ratio of Buy Back = 20 million out of 60 million = 1 out of every 3 shares will be bought back

Total number of outstanding shares AFTER BUYBACK = 60*2/3 = 40 million

Debt will be $200 million. Therefore, Debt per share will be 200/40 = $5 per share

Therefore, Debt for 500 shares will be 500*5 = $2500

In order to undo this debt, he should LEND $2500 by selling 100 shares