Cyberdyne Systems generates perpetual annual EBIT of $200. (Assume that the EBIT

Question

Cyberdyne Systems generates perpetual annual EBIT of $200. (Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year.) Cyberdyne has 1,000 shares outstanding. The stockholders of Cyberdyne require a return of 9%. Assume that Cyberdyne is initially all-equity financed. It is considering an open market stock repurchase. It plans to buy 20% of its outstanding shares. The repurchased shares will be cancelled. It will finance the repurchase by issuing perpetual bonds with a coupon rate (and yield) of 3%. Assume that the tax rate is 40%. What price does Cyberdyne have to offer for repurchased shares such that the repurchase price is equal to the price that prevails after the repurchase is complete? What is the price per share for Cyberdyne stock prior to the repurchase? What is the cost of the repurchased shares? (This is the amount of money that Cyberdyne will borrow.) If Cyberdyne goes ahead with the repurchase, then what is the value of the company after the repurchase is complete? Note: Don't use the pre-repurchase price to calculate the value of the unlevered firm, because the stock price is rounded to two decimals. What is the stock price after the repurchase is complete?

Explanation / Answer

Value of the all equity firm=PV of the EBIT in perpetuity=200/0.09 2222.22 (b)Price per share=Value of the firm/Outstanding share =2222.22/1000 2.22 © Value of 20% of the outstanding share=0.20*1000*2.22 444 (d) Profit=(EBIT-Interest on Bond)*(1-Tax Rate) Profit=(200-0.03*444)*(1-0.40) 112.01 WACC=0.8*0.09+0.2*0.03*(1-0.40) 0.076 Value of the firm=Profit in perpetuity/WAA=112.01/0.076 1473.82 (e) Stock Price=Value of the firm/Outstanding Share=1473.82/(0.8*1000) 1.84

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