Naylor's is an all equity firm with 60,000 shares of stock outstanding at a market price of $50 a share. The company has earnings before interest and taxes of $102,000. Naylor's has decided to issue $750,000 of debt at 7.5 percent. The debt will be used to repurchase shares of the outstanding stock. Currently, you own 500 shares of Naylor's stock. How many shares of Naylor's stock will you continue to own if you unlever this position? Assume you can loan out funds at 7.5 percent interest. Ignore taxes.
Naylor's interest = $825,000 × 0.075 = $61,875
Naylor's shares repurchased = $825,000/$50 = 16,500 Naylor's shares outstanding with debt = 60,000 - 16,500 = 43,500 Naylor's EPS, no debt = $102,000/60,000 = $1.70 Naylor's EPS, with debt = ($102,000 - $61,875)/43,500 = $.9224138 Naylor's value of stock = 43,500 × $50 = $2,175,000 Naylor's value of debt = $825,000 Naylor's total value = $2,175,000 + $825,000 = $3,000,000 Naylor's weight stock = $2,175,000/$3,000,000 = 0.725 Naylor's weight debt = $825,000/$3,000,000 = 0.275 Your initial investment = 500 × $50 = $25,000 Your new stock position = 0.725 × $25,000 = $18,125 Your new number of shares = $18,125/$50 = 362.5 shares Check: Your new loans = 0.275 × $25,000 = $6,875 Your unlevered income = 500 × $1.70 = $850 Your levered income = (362.5 × $0.9224138) + ($6,875 × 0.075) = $850 |
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Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding. The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?
Firm value = 80,000 × ($600,000/12,000) = $4 million
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The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding. The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?
Firm value = 152,000 × ($1.1m/7,500) = $22,293,333
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