Abdul owns 200 shares of Intec Corp. stock. The firm is currently an all equity

Question

Abdul owns 200 shares of Intec Corp. stock. The firm is currently an all equity firm with a market value of $42,000,000 and 1,500,000 shares outstanding. Management of the firm is thinking of borrowing 20% of the current value of the firm and buying back shares with the funds. Even if management goes through with the proposed capital structure change, Abdul will keep all of his shares. There are no taxes or other market imperfections.

4. In numbers, what must Abdul do if the firm goes through with the recapitalization but Abdul wanted the cash flows from the firm as it is currently capitalized? Show your work.

Explanation / Answer

Market Value    42,000,000.00 Shares Outstanding      1,500,000.00 Value per share                     28.00 (42000000/1500000) 20% of market value            8,400,000 No of shares after buyback            1,200,000 Firm now has a debt equity ratio of 80:20 or 4:1 To earn the same cashflow from firm as it is cpitalised , Abdul will have to sell 20% of his stock and invest it in risk free security Shares Abdul owns 200 20% of shares 40 Value of shares to be sold (40*28) 1120

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