The A. J. Croft Company (AJC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6 percent. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero-growth company. AJC”s current cost of equity is 8.8 percent, and its tax rate is 40 percent. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00.
- Now assume that AJC is considering changing from its original capital structure to a new capital structure with 50 percent debt and 50 percent equity. If it makes this change, its resulting market value would be $820,000. What would be its new stock price per share?
Now assume that AJC is considering changing from its original capital structure to a new capital structure that results in a stock price of $64 per share. The resulting capital structure would have a $336,000 total market value of equity and $504,000 market value of debt. How many shares would AJC repurchase in the recapitalization?
. Now assume that AJC is considering changing from its original capital structure to a new capital structure with 50 percent debt and 50 percent equity. If it makes this change, its resulting market value would be $820,000. What would be its new stock price per share?
The new value of equity and debt after the recapitalization:
S = We × Value = 0.5($820,000) = $410,000.
D = WD × Value = 0.5($820,000) = $410,000.
The new price per share after the recapitalization:
Price = (Value of equity + change in debt) ÷ original number of shares
P = [S+ (D1-D0)] ÷ N0
= [$410,000 + ($410,000 -$200,000)] ÷10,000
= $62
4. Now assume that AJC is considering changing from its original capital structure to a new capital structure that results in a stock price of $64 per share. The resulting capital structure would have a $336,000 total market value of equity and $504,000 market value of debt. How many shares would AJC repurchase in the recapitalization?
Number of Shares Remaining:
Number of shares n = Market value of equity ÷ price per share
n = S / P = $336,000 ÷ $64 = 5,250.
The number of repurchased shares is the original number of shares minus the
resulting number of shares:
Number of Shares AJC would repurchase = 10,000 – 5,250 = 4,750.
