Executive Cheese has issued debt with a market value of $118.00 million and has
ID: 2644850 • Letter: E
Question
Executive Cheese has issued debt with a market value of $118.00 million and has outstanding 14.0 million shares with a market price of $10 a share. It now announces that it intends to issue a further $70.00 million of debt and to use the proceeds to buy back common stock. Debtholders, seeing the extra risk, mark the value of the existing debt down to $62 million.
Calculate the market price of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
How many shares can the company buy back with the $70.00 million of new debt that it issues? (Do not round intermediate calculations. Enter your answer in millions rounded to 1 decimal place.)
What is the market value of the firm (equity plus debt) after the change in capital structure? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
What is the debt ratio after the change in structure? (Do not round intermediate calculations.Round your answer to 2 decimal places.)
Executive Cheese has issued debt with a market value of $118.00 million and has outstanding 14.0 million shares with a market price of $10 a share. It now announces that it intends to issue a further $70.00 million of debt and to use the proceeds to buy back common stock. Debtholders, seeing the extra risk, mark the value of the existing debt down to $62 million.
Explanation / Answer
Answer for subpoint a):
Given market value of the Firm = Value of debt+Value of equity
Value of the Firm = Value of the debt +Value of the equity.
=$118 mn+14mn *$10
=$118mn+140mn
=258 mn.
Value of the debt is reduced to $62 million.
Revised value of the equity = $258mn - $62 mn =196 mn.
Number of shares = 14 million
Price of the stock =196mn/14mn = $14 per share.
Answer for Subpoint b:
Market price per share =$14 as calculated from above.
Number of shares the company can buy back with $70mn = $70mn/14 = 5,000,000. shares.
Answer for subpoint c:
Market value of the firm = Value of old debt+new debt+ value of 9 mn shares @$14 per share
=62mn + 70mn+ 126mn
=258 mn.
Answer for Subpoint 4:
Debt ratio = Total liabilities/Total assets
Total assets = Equity + Debt =$258mn
Debt = $70mn+$62mn =$132 mn
Debt ratio = 132mn/258mn = 0.51116 rounded to 0.51
Answer for subpoint e:
The investors in the existing debt lose, while the shareholders gain. It is evident from the market price being $10, before buyback of shares and the same has incresed to $14 per share after the buyback of shares from the proceeds that were obtained by issuing additional debt.
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