6.7. Belo Horizonte Company plans to buy back 1.5 million shares of its own stoc
ID: 2718022 • Letter: 6
Question
6.7. Belo Horizonte Company plans to buy back 1.5 million shares of its own stock from its cash reserves at $65 a share. There will be no change in the debt of the company. This will increase the bankruptcy costs by $13 million, due to lower cash reserves of the company. Due to share buyback, the debt/assets ratio will go from 33% to 37%. The income tax rate of the company is 30%.
(A) Write two equations representing B/V of the company, before and after the share buyback.
(B) Solve them to find the initial and final value of the company.
(C) Calculate the number of shares of stock, before and after the buyback.
Answer: 10,535,750 and 9,035,750. Show solutions.
(D) Find the value of the stock per share after this buyback. Is the company making the right move? Answer: $63.56. Show solutions.
Explanation / Answer
Answer:
Shares buy back = 1.5 million at $65 a share
Increase in bankruptcy cost = $13 million
Therefore,
Number of shares decreases by = 1.5 million
And value of equity reduces by = $65 x 1.5 million = $97.5 million
Debt to asset ratio reduces from 33% to 37%.
Let the debt be x and equity be y.
Then we have:
X / (X+Y) = 33% and X/(X+Y-97.5) = 37%
Solving for X and Y we get:
X = $297.6 million and Y = $604.22 million
Thus we have old debt level = $297.6 million
and old equity level = $604.22 million
So book value of the company before the share buyback
= ($297.6+$604.22)million = $901.82 million
And after the share buyback equity would reduces by $97.5 million and also by $13 million which is bankruptcy cost.
So book value of the company after buyback = ($604.22 - $97.5 -$13) million
= $493.72 million
And the shares outstanding = 9.295 million – 1.5 million = 7.795 million shares.
Therefore price per share after the buyback = $493.72/7.795 = $63.33 per share
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.