The Anderson Company Ltd. (ACL) currently has $200,000 market value (and book va

Question

The Anderson Company Ltd. (ACL) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6%. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. ACL's current cost of equity is 8.8%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00.

Now, assume that ACL is considering changing from its original capital structure to a new capital structure that results in an increased cost of equity to 9.5%. The resulting capital structure would have a $402,684.60 total market value of equity and a $604,026.80 market value of debt. How many shares would ACL repurchase in the recapitalization?

a) 5,008

b) 4,500

c) 6,000

d) 4,250

e) 4,750

Explanation / Answer

Existing market value of firm:

New market value of firm:

Increase in value= 1006711.4- 800000= 206711.4

Total value of equity before repurchase= 600000+206711.4= 806711.4

Value of share before repurchase= 806711.4/10000= 80.67

Amout of equity purchased= amount of debt issued new= 604026.8- 200000= 404026.8

Number of shares purchased= amount purchased/ per share value= 404026.8/80.67= 5008

option.a is correct

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