Realistic Co. has no debt and 7.2 million shares priced at $25/share. Their tax rate is...

Realistic Co. has no debt and 7.2 million shares priced at $25/share. Their tax rate is 30%. If Realistic announces they are going to borrow $80 million of perpetual debt at 7.5% interest and use the money to repurchase shares, what will the new share price be after the repurchase?

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Expert Solution

Before recapitalization

Share outstanding = 7.2 million

Share price per = $25

Value of Firm (unlevered), Vu = 7.2*25 = $180 million

After recapitalization

Debt issued = $80 million

Share repurchased price ( at current price (assumed)) = $25

No. of share repurchased = 80/25 = 3.20 million

No. of share outstanding = 7.2 - 3.2 = 4 million

Now, We can compute the Value of Firm (levered) with M&M proposition-I (with taxation):

where,

VL = Value of levered firm

VU = Value of unlevered firm

D = Debt

t = tax rate (here, 30%)

Thus,

Value of Equity in Levered Firm:

New Share price after repurchas:

jeff jeffy answered 1 year ago

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