Fury Motor Corp.is all equity financed and generates perpetual annual EBIT of $300.Assume that the EBIT,and all other cash flows,occur at year end and that we are currently at the beginning of a year.Assume that Fury has a 100% payout rate,1,500 shares outstanding,and that shareholders require a return of 5%.Assume that the tax rate is 0%.
Fury Motor Corp.is considering an open market stock repurchase.It plans to buy 20% of its outstanding shares at the price of $4.00 per share.The repurchased shares will be cancelled.It will finance the repurchase by issuing perpetual bonds with a coupon rate (and yield)of 3%.Assume that the tax rate is 0%.
If Fury Motor Corp.goes ahead with the repurchase,then what is the stock price after the repurchase is complete?

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Quizplus · Accepted Answer

The stock price is equal to the value of levered equity, E_L, divided by the number of shares outstanding after the repurchase. P = 11ea7fdb_fc60_f7c8_a768_a7c4f49b41c2_TB2902_11 First, determine E_L Since V_L = E_L + D E_L = V_L - D According to M&M Proposition I, the value of the levered firm is equal to the unlevered firm. V_U = V_L Since the value of the unlevered firm is: V_U = 11ea7fdb_fc60_f7c9_a768_fdca9e85aebd_TB2902_11 = 11ea7fdb_fc60_f7ca_a768_e54508bb50ee_TB2902_11 = $6,000 V_L = $6,000 The value of the debt is equal to the price paid for repurchased shares times the number of shares repurchased: D = P_R × N_R D = $4.00 × (0.20 × 1,500) = $1,200 Therefore, E_L = $6,000 - $1,200 = $4,800 The number of shares outstanding after the repurchase is: N_A = 1,500 - (0.2 × 1,500) = 1,200 The price per share is the value of equity divided by the shares outstanding: Price = 11ea7fdb_fc61_1edb_a768_e55ea989f372_TB2902_11 = 11ea7fdb_fc61_1edc_a768_8f1600979642_TB2902_11 = $4.00