Bayani Bakery's most recent FCF was $8 million: the FCF is expected to grow at a...

Bayani Bakery's most recent FCF was $8 million: the FCF is expected to grow at a constant rate of 5% forever. The firm's WACC is 10% and it has 4 million shares of common stock outstanding. The firm will borrow $64 million debt and only make interest payments, and plans to liquidate and distribute to common shareholders via a stock repurchase. The firm has a 40% tax rate.

a) What is the market value of the unlevered firm?

b) What is the share price of the unlevered firm?

c) What is the levered firm value?

d) How will the share price be changing, immediately after the firm announces their share repurchase plan?

e) How many shares will be remains after the firm repurchases stocks?

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Expert Solution

As per Modigilani Approach, value of the enterprise does not depend on the capital structure of the firm. This preposition assumes no tax environment. The approach assumes that any reduction on cost of debt, in turn increases the cost of equity such that overall cost of capital is unchanged thereby the value of the firm is unchanged.

Under the Second Preposition, the value of the firm will increase if the tax picture is considered. Hence value of firm will only increase by the tax portion of debt.

a) We find the value of firm by discounting the future cash flow to present value. Using Gordon Growth Model

Value of firm = FCF (1+ Growth)/ ( Cost - Growth) = 8(1+5%) / ( 10%-5%) = 168 million

b) Share price of equity of unlevered firm = (Firm Value - Debt ) / Number of shares = 168 - 0 / 4 = 42 per share

c) As firm announces the repurchase plan, first the value of firm will increase by the tax portion of debt ( As per MM II Preposition)

Value of levered firm = value of unlevered firm + Tax * Debt

= 168 + 64 * 40% = 193.6

d) Share price of equity of levered firm = (Firm Value levered - Debt ) / Number of shares

= (193.6 - 0) / 4 = 48.4

Note: As currently just the news is announced, debt is not availed to repurchase shares hence debt is nil

e) Shares that will remain after repurchase = Original shares - repurchase shares

i.e Original Shares - Amount Borrowed / Share price

= 4000000 - 64000000 / 48.4

= 4000000 - 1322314

= 2677686 shares

jeff jeffy answered 1 year ago

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