Rally, Inc., is an all-equity firm with assets worth $41 billion and 8 billion s
ID: 2566189 • Letter: R
Question
Rally, Inc., is an all-equity firm with assets worth $41 billion and 8 billion shares outstanding. Rally plans to borrow $13 billion and use funds to repurchase shares. Rally's corporate tax rate is 35%,and Rally plans to keep its outstanding debt equal to $13 billion permanently.
a. Without the increase in leverage, what would be Rally's share price?
b. Suppose Rally offers $5.52 per share to repurchase its shares. Would shareholders sell for this price?
c. Suppose Rally offers $5.80 per share, and shareholders tender their shares at this price. What will be Rally's share price after the repurchase?
d. What is the lowest price Rally can offer and have shareholders tender their shares? What will be its stock price after the share repurchase in that case?
Explanation / Answer
a). Solution :- Share price = Total equity / Number of shares.
= 41 Billion / 8 Billion
= $ 5.125 per share.
Conclusion :- Share price = $ 5.125 per share.
b). Solution :- Calculation of share price before the share repurchase offer :-
Share price = Total equity / Number of shares.
= (41 Billion + 13 Billion + 35 % of 13 Billion - 13 Billion) / 8 Billion
= (41 Billion + 13 Billion + 4.55 Billion - 13 Billion) / 8 Billion
= 45.55 Billion / 8 Billion
= $ 5.69375 per share.
Conclusion :- Shareholders would not sell their shares at the price of $ 5.52 per share because the price of share is $ 5.69375 just before the share repurchase offer presented to the shareholders.
c). Solution :- Calculation of share price after the share repurchase offer :-
Share price = Total equity / Number of shares.
= (41 Billion + 35 % of 13 Billion - 13 Billion) / 5.76 Billion
= (41 Billion + 4.55 Billion - 13 Billion) / 5.76 Billion
= 32.55 Billion / 5.76 Billion
= $ 5.65 per share.
(Number of shares = 8 Billion - 13 Billion / 5.80 = 8 Billion - 2.24 Billion = 5.76 Billion)
Conclusion :- Share price after the repurchase = $ 5.65 per share.
d). Answer :- $ 5.69375 per share. (as calculated in the question b).
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