) GMI Corp., is currently an all-equity firm worth $8.1 million with 340,000 sha
ID: 2686525 • Letter: #
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) GMI Corp., is currently an all-equity firm worth $8.1 million with 340,000 shares of common stock outstanding. GMI plans to issue $1.5 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a 6 percent annual coupon rate. After the sale of the bonds, GMI will maintain the new capital structure as optimal forever. GMI currently generates annual EBIT of $1.95 million. This level of earnings is expected to remain constant in perpetuity. GMI is subject to a corporate tax rate of 40 percent. a. What is the expected return on GMIExplanation / Answer
a. What is the expected return on GMI’s equity before the repurchase of common stock? EBIT = $1.95M SO Earnings for sharegolders NI= EBIT*(1-T) = 1.95M*(1-40%) = $1.17M So ROE = NI/Equity = 1.17M/8.1M = 14.44% b. What is the GMI’s stock price per share immediately after the repurchase announcement? Before annouement, Stock price = Mkt Cap/No of shares = 8.1M/340,000 = $23.82 Shares repurchased = Debt issued / Share price Shares repurchased =1.5M/23.82 = 62,963 So No of shares O/S = 340,000- 62,963 = 277037 SO Stock price after debt =MktCap/ No of shares = $8.1M/277,037 = $29.24 c. How many shares will GMI repurchase as a result of the debt issue? How many shares of common stock will remain after the repurchase? Shares repurchased = Debt issued / Share price Shares repurchased =1.5M/23.82 = 62,963 So No of shares O/S = 340,000- 62,963 = 277037 d. What is the required return on GMI’s equity after the restructuring? Int on Debt = 6%*1.5M = 90000 So NI post Debt = 1.17M-90,000 = $1,080,000 So ROE = NI/Equity = 1080,000/(8.1M-1.5M) = 16.36% e. What is the GMI’s WACC after the restructuring? WACC = WdKd*(1-T) + Ws*Ks = (1.5/8.1)*6%*(1-40%) + (6.6/8.1)*16.36% = 14.00%
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