Rally, Inc., is an all-equity firm with assets worth $54 billion and 12 billion

Question

Rally, Inc., is an all-equity firm with assets worth $54 billion and 12 billion shares outstanding. Rally plans to borrow $27 billion and use funds to repurchase shares. Rally's corporate tax rate is 35%, and Rally plans to keep its outstanding debt equal to $27 billion permanently.

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

b. Suppose Rally offers $5.14 per share to repurchase its shares. Would shareholders sell for this price?

c. Suppose Rally offers $5.44 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. Share price = 54 / 12 = $4.50 per share
b. Just before share repurchase:
Total assets = 54 + 27 + (27 x 0.35) = 90.45
Equity = 90.45 – 27 = $63.45
Share price = 63.45 / 12 = $5.29 per share
Price offered is $5.14 which is lower than worth of share so shareholders will not sell at $5.14

c. Total assets = 54 + (27 x 0.35) = 63.45
Equity = 63.45 – 27 = 36.45
Shares = 12 – 27/5.44 = 7.04 billion
Price = 36.45 / 7.04 = $5.18 per share

d. Fair value of share before repurchase = $5.29
Shares outstanding at this price = 12 – 27/ 5.29 = 6.90 billion and their worth will be 36.45 / 6.90 = $5.28 after the repurchase. Shareholders can sell at this price.

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