The Anderson Company Ltd. (ACL) currently has $200,000 market value (and book va
ID: 2796308 • Letter: T
Question
The Anderson Company Ltd. (ACL) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6%. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. ACL's current cost of equity is 8.8%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00.
Now, assume that ACL is considering changing from its original capital structure to a new capital structure with 50% debt and 50% equity. If it makes this change, its resulting cost of equity would be 9.25%. What would be its new stock price per share?
Explanation / Answer
Total Firm Value = Debt + Equity = 200,000 + 10,000 x 60 = 800,000
With new capital structure, Debt = 50% x 800,000 = 400,000
No. of shares bought with 400,000 = 400,000 / 60 = 6,667 shares.
New outstanding shares = 10,000 - 6,667 = 3,333 shares
Equity Value = (EBIT - Interest) x (1 - tax) / Cost of equity = (100,000 - 400,000 x 6%) x (1 - 40%) / 9.25% = $492,973
New Stock Price = Equity Value / No. of shares = 492,973 / 3,333 = $147.89
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.