Rally, Inc., is an all-equity firm with assets worth $ 20 billion and 8 billion

Question

Rally, Inc., is an all-equity firm with assets worth

$ 20 billion and 8 billion shares outstanding. Rally plans to borrow $ 10 billion and use funds to repurchase shares. Rally's corporate tax rate is 35%,

and Rally plans to keep its outstanding debt equal to $ 10 billion permanently.

a. Without the increase in leverage, what would be Rally's share price?

b. Suppose Rally offers $ 2.76 per share to repurchase its shares. Would shareholders sell for this price?

c. Suppose Rally offers $ 3.08 per share, and shareholders tender their shares at this price. What will be Rally's share price after the repurchase?

d. What is the lowest price Rally can offer and have shareholders tender their shares? What will be its stock price after the share repurchase in that case?

Explanation / Answer

(a) Without the increase in leverage, what would be Rally's share price? Sahre price = Assets worth / Number of Shares =20Billion /8 billion =$2.5 per share (b) Suppose Rally offers $ 2.76 per share to repurchase its shares. Would shareholders sell for this price? Just before the Share purchase Assets =20 Billions + 10 Billion (cash ) +35% 10 Billions (tax shield) =$33.50 Billions Equity = $33.50 Billions - $10 Billions =$23.50 Billions Sahre Price =23.50 Billions /8 Billions =$2.9375 Per share There fore share holders will not sell for $2.76 per share © Rally offers $ 3.08 per share, and shareholders tender their shares at this price. What will be Rally's share price after the repurchase? Assets =$20 Billions +35% *10 Billions (tax shield) =$23.50 Billions equity =$23.50-$10 Billions =$13.50 Billions Shares Purchased = $10 Billions /$3.08 =3.2467 Billions shares Shares after purchases = $8 Billions - 3.2467 Billions =4.7532 Billions Share price after after purchase =$13.50 Billions /4.7532 Billions =$2.8402 (d) What is the lowest price Rally can offer and have shareholders tender their shares? What will be its stock price after the share repurchase in that case? Form (b) fair Value of the shares prior to repurchase =$2.9375 at this price , Sahres outstanding   =8 Billions - ($10 Billions /$2.9375) =4.5957 Billions Shares Shares price After the repurchase = Equity after repurchase / Sahres outstanding =$13.50 Billions /4.5957 Billions =$2.9375 therefore Shares are willing to sell at this price ($2.9375 per share)

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