Pennewell Publishing Inc. (PP) is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT) are $80,000. PP's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.
-Refer to the data for Pennewell Publishing Inc. (PP). Assume that PP is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity. This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638. Assume PP raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase. PP then sells the T-bills and uses the proceeds to repurchase stock. How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase?
A) 7,500; $71.49
B) 7,000; $59.57
C) 6,500; $51.06
D) 6,649; $53.33
E) 6,959; $58.78

Question

Quizplus · Accepted Answer

First, find the stock price after issuing debt but prior to repurchase:
 $\begin{array}{l}
\begin{array}{l}
\text { Value of operations } \
\text { + value of T-bills } \
\text { Total value } \
\text { - value of debt } \
\text { Value of equity } \
\text { Divide by \# shares } \
\text { Price per share }
\end{array}
\begin{array}{r}
\$ 510,638 \
178,723\
\$ 689,361 \
\ 78,723 \
\$ 510,638 \
10,000 \
\$ 51.06
\end{array}
\end{array}$ 
The price per share does not change in the repurchase, so the number of shares repurchased is equal to the amount used to repurchase shares divided by the price per share: Number shares repurchased = $178,723/$51.06 = 3,500. Number shares remaining = 10,000 σ 3,500 = 6,500. As a check, the price per share after repurchase is:
 $\begin{array}{lr}
\text { Value of operations } & \$ 510,638 \
+\text { value of T-bills } &  0\
\text { Total value } &  \$ 510,638 \
 \text { - repurchase } & 178,723 \
\text { Value of equity } & \$ 331,915 \
\text { Divide by \# shares } &  6,500  \
\text { Price per share }&\$ 51.06
\end{array}$