Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth co
ID: 2763609 • Letter: V
Question
Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the market value capital structure indicated below. The money raised would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. EBIT = $80,000 New Debt/Value = 20% Growth = 0% New Equity/Value = 80% Orig cost of equity, rs = 10.0% No. of shares = 10,000 New cost of equity = rs =11.0% Price per share = $48.00 Tax rate = 40% Interest rate = rd = 7.0%
Now assume that VF is considering changing from its original zero debt capital structure to a new capital structure with even more debt. This results in changes in the cost of debt and equity, and thus to a new WACC and a new value of operations. Assume VF raises the amount of new debt indicated below and uses the funds to purchase and hold T-bills until it makes the stock repurchase. What is the stock price per share immediately after issuing the debt but prior to the repurchase?
Debt/Value = 40% Value of new debt = $213,333
Equity/Value= 60% New WACC = 9.0%
$50.67
$53.33
$56.00
$58.80
$61.74
Show calculations
$50.67
$53.33
$56.00
$58.80
$61.74
Show calculations
Explanation / Answer
New Capital structure Debt /Value=0.40 Debt=213333 Enterprice Value =213333/0.40= 533,333 Now before stock repurchase; T-Bills purchased for 213,333 Enterprise value=Equity market value+Debt Market value- Cash & Cash equivalent Cash & Cash equivalent =213333 So 533,333=Equity MV+213333-213333 So Equity Market value before stock repurchase =$533,333 No of Shares outstanding =10000 Price /share before stock repurchase= 533,333/10,000=$53.33 So Market Price is $53.33 before stock repurchase.
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