Question

The Kudos Company (TKC) is in the spaceship industry. Annual EBIT is projected to remain level at $50 million and is received at the end of each year. There are 4 million shares outstanding at a market price of $35 each; there is no debt. TKC is considering approval of a shareholder value plan under which $60 million would be borrowed in perpetuity and then immediately paid out to shareholders as a dividend. This debt bears an interest rate of 8%. TKC has no depreciable assets. The corporate tax rate is 30%; and there are no personal taxes. Markets are frictionless and semi‐strong efficient. (a) Calculate the market price per TKC share just after the : (i) approval of the plan before the public announcement. (ii) public announcement of the plan. (iii) implementation of the plan after the dividend is paid out. (b) Calculate rWACC for TKC after the implementation of the shareholder value plan.

Answer 1

Semi‐strong efficient: A market is semi strong efficient if prices reflect (incorporate) all publicly available information as well as historical price Information.

(a) Calculate the market price per TKC share just after the:

(i) approval of the plan before the public announcement.

Since this is not a public information and market is in Semi Strong Efficient. There will be no effect on Stock Price.

(ii) public announcement of the plan.

After the public announcement it is guaranteed that dividend of

$60 million/ 4 million = $15 is receivable by Shareholder

Therefore, Stock Price declined by $15 to $20 each.

(iii) implementation of the plan after the dividend is paid out.

Particulars	Amount
EBIT	50
Less: Tax 30%	15
FCFF	35
WACC	16.66%
Enterprise Value (FCFF / WACC)	210.11
Less: Debt	60
Equity Value	150.11
No. of Share Holder	4
Share Price	37.53

(b) Calculate rWACC for TKC after the implementation of the shareholder value plan.

Market Value of Equity Share: 4M * $20 = $80M

Market Value of Debt: $60M

Weight of Equity: 80 / (80 + 60) = 57%

Weight of Equity: 60 / (80 + 60) = 43%

Cost of Equity (Ke) =

Particular	Amount
EBIT	50
Less: Tax 30%	15
EAT	35
No. of Share Holder	4
EPS	8.75
Price	35
Ke (Since there is no growth)	25%
(EPS / Price) * 100

Cost of Debt (Kd) = 8% * (1 – 30%) = 5.6%

WACC: 57% * 25% + 43% * 5.6%

= 16.658%

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