Henderson's is an all-equity firm that has 135,000 shares of stock outstanding. Neal, the financial vice-president, is considering borrowing $220,000 at 7.25 percent interest to repurchase 20,000 shares. Ignoring taxes, what is the value of the firm?

Question

Quizplus · Accepted Answer

Before repurchasing shares, the value of Henderson's firm is:

135,000 shares * P = Firm Value

After repurchasing 20,000 shares, there will be 115,000 outstanding shares, so the new share price will be:

$220,000 / 20,000 shares = $11 per share repurchased

New value of Henderson's firm:

115,000 shares * (P + $11) = $220,000 + Firm Value

Setting the before and after firm values equal:

135,000 shares * P = 115,000 shares * (P + $11) - $220,000

Solving for P:

P = $15

Therefore, the value of the firm after the share repurchase is:

115,000 shares * ($15 + $11) = $1,485,000

Henderson's Is an All-Equity Firm That Has 135,000 Shares of Stock