Executive Chalk is financed solely by common stock and has 25 million shares out
ID: 2633984 • Letter: E
Question
Executive Chalk is financed solely by common stock and has 25 million shares outstanding with a market price of $10 a share. It announces that it intends to issue $160 million of debt and use the proceeds to buy back common stock. Assume that the MM assumptions hold (i.e., no taxes, no costs of financial distress). a) What is the value of the firm before and after the proposed capital structure change? b) What is the debt-to-equity ratio after the capital structure change? c) What is the stock price after the capital structure change? d) Who (if anyone) gains or loses?
Explanation / Answer
a) The value of the firm before debt issue is total number of equity shares multiplied with the price per share.
Total value of equity = (25,000,000 X $10 ) = $250,000,000
The value of the firm after change in capital structure is total value of equity and debt.
Since the proceeds from debt are used to repurchase the common shares, the
Value of equity = $250,000,000 - $160,000,000 = $90,000,000
Value of debt = $160,000,000
Total value of firm after change in capital structure = $90,000,000 + $160,000,000 = $250,000,000
b) Debt equity ratio is total debt divided by total equity.
Debt equity ratio = $160,000,000 / $90,000,000 = 1.78 times
c) There would be no change in the stock price after change in the capital structure.
d) No one gains or loses.
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