Topsy Breweries Inc.,a UK brewer headquartered in Turvey,is all equity financed and generates perpetual annual EBIT of $800.Assume that the EBIT,and all other cash flows,occur at year end and that we are currently at the beginning of a year.Topsy has 2,000 shares outstanding which trade for $4.00.The stockholders of Topsy require a return of 7%.Topsy is considering an open market stock repurchase.It plans to buy 15% of its outstanding shares at a price of $4.188.The repurchased shares will be cancelled.It will finance the repurchase by issuing perpetual bonds with a coupon rate (and yield)of 4%.Assume that the tax rate is 30%.What is the price of Topsy shares after the repurchase (P_A)?

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This solution uses Modigliani & Miller Proposition I with taxes. V_U = 11ea7fdb_fc65_b303_a768_9dd5c131ef41_TB2902_11 V_U = 11ea7fdb_fc65_b304_a768_53153e4acadd_TB2902_11 = $8,000 After the repurchase, debt equals the cost of the repurchase: D = P_R × N_B × f D = $4.188 × 2,000 × 0.15 = $1,256.55 The value of the (levered) firm after the repurchase is: V_L = V_U + T × D V_L = $8,000 + 0.30 × $1,256.55 = $8,376.96 The value of levered equity after the repurchase is: E_L = V_L - D E_L = $8,376.96 - $1,256.55 = $7,120.42 The stock price is after the repurchase is: Price = 11ea7fdb_fc65_b305_a768_3f70726af8e6_TB2902_11 Solve for the number of shares outstanding, N_A. N_A = N_B - N_R N_A = 2,000 - (0.15 × 2,000) = 1,700 Therefore, the stock price after the repurchase is: Price = 11ea7fdb_fc65_b306_a768_6342e9355572_TB2902_11 = $4.188 or $4.19