An all-equity firm with 200,000 shares outstanding, Antwerther Inc., has $2,000,

Question

An all-equity firm with 200,000 shares outstanding, Antwerther Inc., has $2,000,000 of EBIT, which is expected to remain constant in the future. The company pays out all of its earnings, so earnings per share (EPS) equal dividends per shares (DPS). Its tax rate is 40%.

The company is considering issuing $5,000,000 of 10.0% bonds and using the proceeds to repurchase stock. The risk-free rate is 6.5%, the market risk premium is 5.0%, and the beta is currently 0.90, but the CFO believes beta would rise to 1.10 if the recapitalization occurs.

Assuming that the shares can be repurchased at the price that existed prior to the recapitalization, what would the price be following the recapitalization?

$76.33

$69.23

$80.14

$65.77

$72.69

$76.33

$69.23

$80.14

$65.77

$72.69

Explanation / Answer

PRESENT RECAP cost of equity rf 6.50% 6.5 6.5 beta 0.9 0.9 1.1 market risk premium 5.00% 5 5 beta* market risk premium 4.5 5.5 return= 11 12 % return = 11.00% 12.00% PRESENT RECAP $ EBIT 2000000 2000000 INT 0 500000 PBT 2000000 1500000 TAX@40% 800000 600000 PAT 1200000 900000 NUMBER OF SHARES 200000 108333 EPS 6 8.3076923077 DPS = 100% of EPS 6 8.3076923077 PRICE PER SHARE before recap 54.5454545455 NUMBER OF SHARES THAT CAN BE BOUGHT = $5,000,000/ price per share before recap 91667 NUMBER OF SHARES LEFT = 200000-number of shares that can be bought for recap 108333 PRICE AFTER RECAP = DPS/ cost of equity after recap 69.2307692308 answer B

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