Question

Kurz Manufacturing is currently an​ all-equity firm with 18 million shares outstanding and a stock price of $ 11.50 per share. Although investors currently expect Kurz to remain an​ all-equity firm, Kurz plans to announce that it will borrow $ 45 million and use the funds to repurchase shares. Kurz will pay interest only on this​ debt, and it has no further plans to increase or decrease the amount of debt. Kurz is subject to a 30 % corporate tax rate. a. What is the market value of​ Kurz's existing assets before the​ announcement? b. What is the market value of​ Kurz's assets​ (including any tax​ shields) just after the debt is​ issued, but before the shares are​ repurchased? c. What is​ Kurz's share price just before the share​ repurchase? How many shares will Kurz​ repurchase? d. What are​ Kurz's market value balance sheet and share price after the share​ repurchase?

Answer 1

a). Assets = Equity = $11.50 x 18 million = $207 million

b). Assets = Existing + Cash + Tax Shield = 207 + 45 + [0.30 x 45] = $265.50 million

c). E = Assets - Debt = 265.50 - 45 = $220.50 million

Share Price = Equity / No. of Shares Outstanding = 220.5/18 = $12.25/share

No. of shares repurchased = Debt / Share Price = 45 million/12.25 = 3.67 million

d). Assets = Existing + Tax Shield = 207 + [0.3 x 45] = $220.50 million

Debt = $45 million

E = A - D = 220.50 - 45 = $175.50 million

Share Price = Equity / No. of Shares Outstanding = 175.5/[18 - 3.67] = $12.25/share