Question

The Kim Su Company is planning to repurchase shares of common stock with the proceeds of a $50,000,000 debt issue. The interest rate on the debt is expected to be 10%. Currently, Kim Su is unlevered with 12,000,000 common shares outstanding. The price-earnings ratio of the common shares is 5 on pre-tax operating income of $30,000,000. The equity has a required rate of return of 20% based on an equity beta of 1.20. Assuming the company’s tax rate is 34%, there are no personal taxes and all cash flows are level perpetuities, answer the following questions. (1) Compute the company’s earnings per share, stock price and market value before the debt issue and stock repurchase. (4 points) (2) Compute the company’s earnings per share, stock price and market value after the debt issue and stock repurchase. (6 points) (Hint: After the repurchase we have fewer shares: Shares repurchased = N = D/PN where PN is the price of the repurchase (and the price after the repurchase) So, D= (N)(PN) and we know E = (PN) (Shares outstanding - N) from the 2 equations above we can solve for PN and N.)

Answer 1

Part 1:	Calculation of EPS, Stock Price, Market Value of stock before debt issue and stock purchase
	Pre tax operation Income	$ 30,000,000.00
	Less : Tax @34%	$ 10,200,000.00
	Post Tax Income (A)	$ 19,800,000.00
	No. of Share (B)	12000000
	EPS (A/B)		$                     1.65
		PE Ratio	5
		EPS	1.65
	Stock Price per share	PE Ratio * EPS
			5*1.65 = 8.25
	Market value = Stock Price * no .of stock
		8.25*12000000 =	99000000
Part 2 :	Calculation of EPS, Stock Price, Market Value of stock before debt issue and stock purchase
	No. of Share Repurchased	Debt value / value of repurchased share
	Let say No. of share repurchased = X
	Per share value of repurchased share = y
	Then X= 50,000,000/Y
	XY = 50,000,000 …….. Eq(1)
	Value of equity = Per share repurchased value*(Total no. of equity share- No. of repurchased share)
	99000000= Y *(12000000-X)
	99000000 = 12000000Y - XY
	XY= 50000000
	99000000=12000000Y-50000000
	149000000= 12000000Y
	Y= 149000000/12000000
	Value of repurchased Share price	12.416666667
	No. of Repurchased share	50000000/12.416666667
	No. of Repurchased share	4026846
	No. of remaining share = 12000000-4025765	7973154
	Pre tax operation Income	$ 30,000,000.00
	Less : Interest	$    5,000,000.00
	Pre tax profit	$ 25,000,000.00
	Less : Tax @34%	$ 10,200,000.00
	Post Tax Income (A)	$ 14,800,000.00
	No. of Share (B)	7973154
	EPS (A/B)		$                     1.86
	Market Price Per share = EPS/Re
	Where Re = 20*1.20 =24%
	MPS = 1.86/24% = 7.75
	Market Value =7.75*7973154 =61791944