Question

KMS Corporation has assets with a market value of $750M, $50M of which are cash. It has debt with a market value of $300M, and 10M stock shares outstanding. Assume perfect capital markets.

a) A firm’s stock price is equal to the market value of equity divided by the number of shares outstanding. What is the current stock price? (Hint: TA = D + E)

b) If KMS distributes $50M as a dividend, what will its share price be after the dividend is paid?

c) If instead KMS distributes $50M as a share repurchase, what will its share price be after the shares are repurchased? Show your calculations that you use to arrive to this share price. Also show how many shares KMS repurchased.

d) What is the market debt-to-value ratio (D/(D+E)) in part (a)? What is the market debt-to-value ratio (D/(D+E)) after the dividend is paid in part (b)? What is the market debt-to-value ratio (D/(D+E)) after the share repurchase in part (c)? How does a payout affect the debt-to-value ratio?

Answer 1

1-	market value of equity = market value of assets-market value of debt	750-300	450
	no of shares outstanding		10
	market share price	450/10	45
2-	market value of equity = market value of assets-market value of debt	750-300-50	400
	no of shares outstanding		10
	market share price	450/10	40
3-	no of shares purchased	amount to be used to purchase stock/market price of stock	50/45	1.111111111
	no of shares outstanding	50-1.111	48.889
	market value of equity = market value of assets-market value of debt	750-300-50	400
	no of shares outstanding	10-1.111	8.889
	market share price	450/10	45.00
4-	debt to value ratio	300/750	40.00%
b	debt to value ratio	300/700	42.86%
c-	debt to value ratio	300/700	42.86%
	A payout will increase the debt to equity ratio as decrease in pay out would reduce the value of equity which will result in increasing debt to value ratio