JanAm generates $30 million in perpetual operating income (i.e., no change in in
ID: 2718770 • Letter: J
Question
JanAm generates $30 million in perpetual operating income (i.e., no change in investment policy). The company has a market capitalization of $100,000,000, and its share is currently selling at $100 per share. The firm has $100,000,000 in debt obligation, with an interest rate of 10%. The firm wants to increase its leverage by repurchasing 200,000 shares of its outstanding stock at the prevailing market price ($100 per share) and plans to finance the equity repurchase by issuing $20,000,000 bond at 10%.
1. How can investors undo the effect of JanAm's capital structure change?
2. What obstacles will investors run into in real life, preventing them from completing the necessary transactions to undo JanAm's capital structure change?
Explanation / Answer
Solution 1. The firm wants to increase its leverage by repurchasing 200,000 shares of its outstanding stock at the prevailing market price ($100 per share) and plans to finance the equity repurchase by issuing $20,000,000 bond at 10%.
So, the effect of such capital structure change are:
All Capital Structure Proposals are presented in shareholders General Meeting and have to pass through for its implementation. The investors / Shareholders can undo JanAm's capital structure change with the above effects by declining (or not passing) the agenda for re-structuring of Capital Structure of buying the shares of its outstanding stock by financing the same with issue of Debt Bonds in the General Shareholders Meeting. The Shareholders are the legal owner of the Company, so they have the right to not let the proposal pass through the General Meeting of Shareholders.
Solution 2. The investors / Shareholders can in real life prevent them from completing the necessary transactions to undo JanAm's capital structure change by-
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