Harris Corporation is an all-equity firm with 100 million shares outstanding. Harris has $250 million in cash...

Harris Corporation is an all-equity firm with 100 million shares outstanding. Harris has $250 million in cash and expects future free cash flows of $85 million per year. Management plans to use the cash to expand the firm’s operations, which will in turn increase future free cash flows by 15%. If the cost of capital of Harris’ investments is 12%, how would a decision to use the cash for a share repurchase rather than the expansion change the share price?

Expert Solution

– If Harris corporation uses the cash to expand, its future free cash flows will increase by 15% i.e $97.75 million per year ($85 million * 1.15) . Using the perpetuity formula, its market value will be $97.75 million ÷ 0.12 = $814.58 million, or $814.58 million ÷ 100 million shares = $8.146 per share.
	– If Harris corporation does not expand, the value of its future free cash flows will be $85 million ÷ 0.12 = $708.33 million. Adding the cash, Harris corporation’s market value is $958.33 million, or $958.33 million ÷ 100 million shares = $9.583 per share.
		– If Harris corporation repurchases shares, there will be no change to the share price: It will repurchase $250 million ÷ $9.583 per share = 26.09 million shares, so it will have assets worth $ 708.33 million with 73.91 million shares outstanding (100 million – 26.09 million), for a share price of $9.583 per share ($708.33 billion ÷ 73.91 million share)
			– Thus, repurchase is better than expansion since there is no change in share price and increase in value of assets

jeff jeffy answered 9 months ago

Zetatron is an all-equity firm with 100 million shares outstanding, which are currently trading for...

Zetatron is an all-equity firm with 100 million shares outstanding, which are currently trading for $7.50 per share. A month ago, Zetatron announced it will change its capital structure by borrowing $100 million in short-term debt, borrowing $100 million in long-term debt, and issuing $100 million of preferred stock. The $300 million raised by these issues, plus another $50 million in cash that Zetatron already has, will be used to repurchase existing shares of stock. The transaction is scheduled...

AHN is firm manufacturer. The firm is all-equity financed and has 40 million shares outstanding at...

AHN is firm manufacturer. The firm is all-equity financed and has 40 million shares outstanding at a price of $75 per share. AHN current cost of capital is 7.5%. The firm is considering to buy back $400 million in shares in the open market and to finance the repurchase by issuing bonds. AHN plans to maintain this capital structure indefinitely. At this level of debt, the bonds would be A-rated, and the firm would pay an interest rate of 4.5%.AHN's...

MBM Industries is an all-equity firm with 50 million shares outstanding. MBM has £200 million in...

MBM Industries is an all-equity firm with 50 million shares outstanding. MBM has £200 million in cash and expects future free cash flows of £75 million per year. Management plans to use the cash to expand the firm's operations, which in turn will increase future free cash flows by 12%. MBM's cost of capital is 10%; assume that capital markets are perfect. i. What is the value of MBM if it uses the £200 million to expand? ii. What is...

You are managing an all-equity firm that has 1 million shares outstanding in year 0. The...

You are managing an all-equity firm that has 1 million shares outstanding in year 0. The firm has fixed assets with value A, which is constant over time. As the manager, you know the value of A but investors only learn it in year 3; as a result, the market price of shares in year 3 will reflect the value of A.In addition to the fixed assets firm has 1million pound of excess cash at year 0 deposited in a...

ABC Corporation is financed entirely by equity, has 1 million shares outstanding trading at $100 per...

ABC Corporation is financed entirely by equity, has 1 million shares outstanding trading at $100 per share. Depending on the state of the economy its EBIT will be recession expected expansion 8 million 12 million 16 million XYZ Corporation has exactly the same EBIT in each economy state, but has $40 million of debt outstanding with an 8% interest rate. It also has 600,000 shares of common stock outstanding priced at $95 per share. Neither firm pays taxes. There are...

An all-equity business has 100 million shares outstanding, selling for $20 a share. Management believes that...

An all-equity business has 100 million shares outstanding, selling for $20 a share. Management believes that interest rates are unreasonably low and decides to execute a dividend recapitalization. It will raise $1 billion in debt and repurchase 50 million shares. Do equity shareholders appear to have gained or lost as a result of the recap? Please explain. Assume now that the recap increases total firm cash flows, which adds $100 million to the value of the firm. Now what is...

4. Clarkson Corporation is currently an all equity firm that has 450,000 shares of stock outstanding...

4. Clarkson Corporation is currently an all equity firm that has 450,000 shares of stock outstanding with a market price of $52.40 a share. The current cost of equity is 10.5 percent and the tax rate is 25 percent. The firm is considering adding $6.3 million of debt with a coupon rate of 6 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity? a $18,855,000 b $19,247,000 c...

Ashman Motors is currently an all-equity firm. It has two million shares outstanding, selling for $37...

Ashman Motors is currently an all-equity firm. It has two million shares outstanding, selling for $37 per share. The company has a beta of 0.9, with the current risk-free rate at 3.1% and the market premium at 7.6%. The tax rate is 25% for the company. Ashman has decided to sell $37 million of bonds and retire half its stock. The bonds will have a yield to maturity of 7.4%. The beta of the company will rise to 1.3 with...

Your company is an all-equity firm and has 1 million shares outstanding and its current market...

Your company is an all-equity firm and has 1 million shares outstanding and its current market value is $10 million, with an operating income (EBIT) is $1.5 million. This morning your company issued $2 million of debt at a 10% coupon rate and used the proceeds to repurchase your company’s shares from the stock market. The transaction is completed before the end of the day. Your company’s cost of capital is 6% and the corporate income tax rate is 20%....

XYZ Satellites Inc. is an all equity firm with 200,000 shares outstanding and $20 million in...

XYZ Satellites Inc. is an all equity firm with 200,000 shares outstanding and $20 million in earnings after taxes with a market value of $350 million.The company borrows $75 million to repurchase#50000 shares @8%.The tax rate is 50%. 1) What effect will this have on the earning per share of the firm? 2) At what interest rate would have to be on the debt for the EPS effect to disappear?

Question