Multi-Part 15-2: Volunteer Fabricators, Inc. (VF) currently has zero debt. It is
ID: 2672593 • Letter: M
Question
Multi-Part 15-2:Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the market value capital structure indicated below. The money raised would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.
EBIT =
$80,000
New Debt/Value =
20%
Growth =
0%
New Equity/Value =
80%
Orig cost of equity, rs =
10.0%
No. of shares =
10,000
New cost of equity = rs =
11.0%
Price per share =
$48.00
Tax rate =
40%
Interest rate = rd =
7.0%
Refer to Multi-Part 15-2. Based on the data in the previous two problems, what would the stock price be if VF issued the new debt and immediately used the proceeds to repurchase stock?
Answer
$49.43
$50.70
$52.00
$53.33
$56.00
Explanation / Answer
answer: $53.33 details... The price per share does not change in the repurchase. As a check, consider the following data: Value of operations = EBIT(1 - T)/WACC $533,333 + value of T-bills 0 Total value $533,333 - repurchase -213,333 Value of equity $320,000 New shares = old - Debt/Price = 6,000 Stock price = Equity divided by # shares $ 53.33
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