Question

KMS Corporation has assets with a market value of ​$522 ​million, ​$32 million of which are cash. It has debt of ​$294 ​million, and 13 million shares outstanding. Assume perfect capital markets.

a. What is its current stock​ price?

b. If KMS distributes ​$32 million as a​ dividend, what will its share price be after the dividend is​ paid?

c. If​ instead, KMS distributes ​$32 million as a share​ repurchase, what will its share price be once the shares are​ repurchased?

d. What will its new market​ debt-equity ratio be after either​ transaction?

Answer 1

We Know

Assets - Liability = Equity

In perfect capital markets

Assets = ​$522 ​million

Liability = ​$32 million  

Equity = 522 - 294 = $ 228 million  

current stock​ price = Equity / No of Shares Outstanding =  $ 228 million / 13 million = $ 17.53

Ans (a) current stock​ price = $ 17.53

After distribution of  ​$32 million as a​ dividend,

Reduced Assets = Assets - Dividend Paid =  ​$522 ​million -- ​$32 million =   $ 490 million .

Now,

Reduced Assets - Liability = Equity

Equity = 490 - 294 = $ 196 million

current stock​ price = Equity / No of Shares Outstanding = $ 196  million / 13 million = $ 15.07

Ans (b) share price be after the dividend is​ paid = $ 30 (Ans)

No of Shares Purchased = Shares Purchased Amount / current stock​ price

Shares Purchased Amount = $ 32 million

current stock​ price = $ 17.53

No of Shares Purchased = $ 32 million / $ 17.53 = 1.825  Million

Current O/S Shares = Previously Total No of Shares - Share Purchased =  13 million - 1.825 Million

= 11 .175 Million

Now,

Reduced  Assets - Liability = Equity

Reduced Assets =  Assets - Shares Purchased Amount = ​$522 ​million -    $ 32 Million = $ 490 million

Equity = 490 - 294 = $ 196million

current stock​ price = Equity / No of Shares Outstanding =  $ 196 million / 11 .175 Million =  $ 17.53

Ans (c )share price be once the shares are​ repurchased = $ 17.53 (Ans)

Now Assets – asset reduction –liabilities = Equity

Asset Reduction in each case b and c = $ 32  million

Equity = 522 - 32 - 294 = $ 196 million

Debt / Equity = 294 / 196 = 1.5

Ans (d)  market​ debt-equity ratio be after either​ transaction = 1.5 (Ans)