Executive Cheese has issued debt with a market value of $112.64 million and has
ID: 2767766 • Letter: E
Question
Executive Cheese has issued debt with a market value of $112.64 million and has outstanding 14 6 million shares with a market price of S10 a share It now announces that it Intends to issue a further $58.96 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 $63 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 $58 96 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 m 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.) Who (if anyone) gains or loses? The investors in the existing debt lose while the shareholders gain The investors m the existing debt gam while the shareholders lose.Explanation / Answer
A.)
The market value of the firm’s equity increases by $49.64 million, the amount of the decrease in the market value of the firm’s existing debt.(112.64-63)
Therefore, the price of the stock increases to:($146 million + $49.64 million) / 14.6 million shares = $13.4
.Note that this is an outcome of the pure shift of one liability into another. In perfect capital markets(whereas there are no issues associated with taxes, bankruptcy, signaling of information) that is the ONLY effect
B)
Since the market price of the shares is $13.4, the company can buy back:$58.96 million / $13.4 = 4.4 million shares
c.)
After the change in capital structure, the market value of the firm is unchanged
Equity + Debt = (10.2 million x $13.4) + $121.96 million = $258.64 million
d.)
After the change in structure, the debt ratio is
:Debt / (Debt + Equity) = $121.96 million / $258.64million
= 0.47
e.)
The investors in the existing debt lose $49.64 million while the shareholders gain this$49.64 million. The value of each share increases by:$49.64 million / 14.6 million shares = $3.4.
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