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KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt.KD has had consistently stable earnings,and pays a 21% tax rate.Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
-If KD expects the share price to increase from $20 per share to a new share price on announcement of the transaction and before the shares are repurchased,what will the new share price be after the announcement?

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Quizplus · Accepted Answer

The increase in share price is due to the tax shield from the debt. The tax shield is $200 million * 21% = $42 million. The value of the firm increases by this amount, so the new market value is $600 million + $42 million = $642 million. Dividing by the 30 million shares gives a new share price of $21.40.

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