Question

Executive Chalk is financed solely by common stock and has outstanding 27 million shares with a market price of $14 a share. It now announces that it intends to issue $210 million of debt and to use the proceeds to buy back common stock.

a. How is the market price of the stock affected by the announcement?

	Stock price remains the same.
	Stock price increases.
	Stock price decreases.

b. How many shares can the company buy back with the $210 million of new debt that it issues? (Enter your answer in millions.)

Shares repurchased             million

c-1. What is the market value of the firm (equity plus debt) after the change in capital structure? (Enter your answer in millions.)

Market value            $  million

c-2. Did the market value of the firm change?

	No
	Yes

d. What is the debt ratio after the change in structure? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Debt ratio            

e. Who (if anyone) gains or loses?

	No one gains or loses.
	Shareholders gain and debtholders lose.
	Debtholders gain and shareholders lose.
	Shareholders gain and no one loses.

Answer 1

Answer a

The market price of the stock is not affected by the announcement

Answer b

Since the market price of the shares is $14, the company can buy back:

$210 million/$14 = 15 million shares

Answer c

After the change in capital structure, the market value of the firm is unchanged:

Equity + Debt = (12 million x $10) + $210 million = $370 million

Market value has increased.

Answer d

After the change in structure, the debt ratio is:

Debt/(Debt + Equity) = $210 million/$370 million = 0.568

Answer e

Shareholders will gain as now eps will increase due to a reduction in the total number of shares. And no one loses