Question

Kurz Manufacturing is currently an​ all-equity firm with 38 million shares outstanding and a stock price of $14.50 per share. Although investors currently expect Kurz to remain an​ all-equity firm, Kurz plans to announce that it will borrow $35 million and use the funds to repurchase shares. Kurz will pay interest only on this​ debt, and it has no further plans to increase or decrease the amount of debt. Kurz is subject to a 30% corporate tax rate.  

a. What is the market value of​ Kurz's existing assets before the​ announcement?

b. What is the market value of​ Kurz's assets​ (including any tax​ shields) just after the debt is​ issued, but before the shares are​ repurchased?

c. What is​ Kurz's share price just before the share​ repurchase? How many shares will Kurz​ repurchase?

d. What are​ Kurz's market value balance​ sheet, and share price after the share​ repurchase?

Answer 1

a. The market value of existing assets before the announcement is calculated as follows:-

Assets = Equity = Stock price x Number of shares outstanding

Assets = $14.50 x 38

Assets = $551 million

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b. The market value of​ assets​ (including any tax​ shields) just after the debt is​ issued, but before the shares are​ repurchased

Assets = Existing assets + Cash + Tax shield

Assets = $551 + $35 + $35 x 0.30

Assets = $596.5 million

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c. First, we calculate the equity

Equity = Assets - Debt

Equity = $596.5 - $35

Equity = $561.5 million

Now, we find the share price

Share price = Equity/Number of shares outstanding

Share price = $561.5/38

Share price = $14.78

Number of shares repurchase = 35/14.78

Number of shares repurchase = 2.368 or 2,368,000 shares

Therefore, the price just before the share​ repurchase is $14.78 and number of shares repurchase is 2,368,000.

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d. We calculate the asset first.

Asset = Existing asset + Tax shield on debt

Asset = $551 + 30% x $35

Asset = $561.5

Now, we find the equity

Equity = Asset - Debt

Equity = $561.5 - $35

Equity = $526.5

So, the share price is

Share price = $526.5/(38 - 2.368)

Share price = $14.78

Hence, the market value of asset = $561.5, equity = $526.5 and share price = $14.78 after the share repurchase.