Cyberdyne Systems generates perpetual annual EBIT of $200. (Assume that the EBIT

Question

Cyberdyne Systems generates perpetual annual EBIT of $200.  (Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year.)  Cyberdyne has 1,000 shares outstanding which trade for $1.33.  The stockholders of Cyberdyne require a return of 9%.  Assume that Cyberdyne is initially all-equity financed.  It is considering an open market stock repurchase.  It plans to buy 20% of its outstanding shares.  The repurchased shares will be canceled.  It will finance the repurchase by issuing perpetual bonds with a coupon rate (and yield) of 3%.  Assume that the tax rate is 40%.

Q 5 - What is the stock price after the repurchase is complete?

Explanation / Answer

Value of firm = 1,000 x 1.33 = 1,330

Debt = 20% x 1,330 = 266. No of shares repurchased = 20% x 1000 = 200

Cost of levered equity = ru + (1 - tax) x D/E x (ru - rd) = 9% + (1 - 40%) x 20/80 x (9% - 3%) = 9.9%

Value of equity = (EBIT - Interest) x (1 - tax) / Cost of equity

= (200 - 266 x 3%) x (1 - 40%) / 9.9%

= $1,163.76

=> Stock Price = Value of equity / No. of shares = 1,163.76 / 800 = $1.45

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