Question

Executive Cheese has issued debt with a market value of $100 million and has outstanding 15 million shares with a market price of $10 a share. It now announces that it intends to issue a further $60 million of debt and to use the proceeds to buy back common stock. Debtholders, seeing the extra risk, mark the value of the existing debt down to $70 million. a. How is the market price of the stock affected by the announcement? b. How many shares can the company buy back with the $60 million of new debt that it issues? c. What is the market value of the firm (equity plus debt) after the change in capital structure? d. What is the debt ratio after the change in structure?

Answer 1

The solution to the required questions are

a) NP= 5 Million share

b) EP= $12

c) MVF = $250 million

d) DR= 0.52

What is the debt ratio after the change in structure?

a)

Generally, the equation for Market price per share is  mathematically given as

Increase in the equity's worth in the market

Equity's worth = ($100-$70)

Equity's worth= 30 million

Complete amount of equity value

Equity value= 15*$10 + 30

Equity value = 180 million

Price on the Market for Each Equity

EP = $180/15

EP= $12

b)

The corporation is able to purchase back the shares at the market price of $12 per share.

MP= $60 million/$12

MP = 5 million shares

The total number of buybacks

NP= 5 Million share

c.)

Following the repurchase of shares, the total number of shares in circulation is now equal to 15 million minus 5 million, which is 10 million.

Equity's current value on the market

MVE= 10 x  12

MVE= $ 120 million.

MVE = $ 70 + $ 60

MVD = $ 130 million

MVF = $120+ 130

MVF = $250 million

Market value of firm = $250 million

d)

In conclusion,

$Debt ratio = \frac{Value\ of\ Debt}{ Value\ of\ Firm}$

$Debit Ratio=\frac{ 130}{250 }$

DR= 0.52

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