Rally Inc. is an all-equity firm with assets worth $25 billion and billion share

Question

Rally Inc. is an all-equity firm with assets worth $25 billion and billion shares outstanding. Rally plans to borrow $10 billion and use these funds to repurchase shares. The firms corporate tax rate is 35%, and Rally plans to keep its outstanding debt equal to $10 billion permanently.

A. Without the increase in leverage, what would Rally's share price be?

B. Suppose Rally offers $2.75 per share to repurchase its shares. Would shareholders sell for this price?

C. Suppose Rally offers $3.00 per share and shareholders tender their shares at this price. What will Rally's share price be 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. Share Price = 25/10 = $2.5 per share.

b. Just before the share repurchase:

Assets = 25 existing 10 cash 35% 10 tax shield $38.5 billion

E = 38.5 - 10 = 28.5 billion

Share Price = 28.5/10 = $2.85 per share.

c. Assets = 25 (existing) + 35%× 10 (tax shield) = $28.5 billion

E = 28.5 - 10 = 18.5 Billion

Shares = 10 - 10/3 = 6.667 billion

Share Price = 18.5/6.667 = $2.775 per share

d. From (b), fair value of the shares prior to repurchase is $2.85. At this price, Rally will have 10 - 10/2.85 = 6.49 million shares outstanding, which will be worth 18.5/6.49 = $2.85 after the repurchase. Therefore, shares will be willing to sell at this price.

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