Question

Suppose that capital markets are perfect, meaning that they are complete, efficient and there are no frictions such as taxes. AH Belo Corp currently is 100% equity financed, with a market capitalization of $1 billion but has decided to add some debt to its capital structure. It will do so by raising $100 million in debt and using the proceeds to repurchase shares. Which of the following accurately describes the effect of this policy change on the company's stock price?

Group of answer choices

It will decline when the financing plan is announced, but will not change any further when it is implemented.

It will increase when the financing plan is announced, but will not change any further when it is implemented.

It will not change.

It will decline both when the policy is announced and when it is implemented.

It will increase both when the policy is announced and when it is implemented.

Answer 1

ANSWER:

Share repurchase

It will increase both when the policy is announced and when it is implemented.

First, stock price increases when the intention to repurchase is announced, as it is seen by the potential investors , as a positive sign that the company has surplus cash after meeting all its debt obligations & also

that the management is quite confident in its belief that their stock is under-valued in the market and intends to push up the price, by this repurchase.

After, buyback is implemented, it pushes up the price , as all the indicating ratios like

return on assets (cash has been spent on repurchase , so assets decrease , so the ratio, ROA= net income/total assets increase ,

return on equity (Equity has reduced & so the ratio ROE=Net income/Total equity increase &

earnings per share (Net income/Reduced No.of equity shares, increases the EPS )show improvement ,

compared to that before buyback announcement & so there are many more buyers.

Supply of stock is less, whereas, demand is more & that pushes up the per share price.