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You are the CFO of UBT Inc. and you are considering conducting a levered recapitalization. Specifically,...

You are the CFO of UBT Inc. and you are considering conducting a levered recapitalization. Specifically, you are planning on issuing a perpetual bond with a face value of $1,500 million and you will use all of the proceeds from this bond issuance to pay your existing shareholders a one-time dividend. You anticipate that the cost of debt associated with this transaction will be 4.1%.

You believe that increasing UBT’s leverage will benefit investors. Specifically, you anticipate that this expected agency benefit has a present value of $50 million. You do not anticipate any agency or distress costs as a result of this transaction.

The table below shows additional information on UBT Inc. before the new bond is issued. You may assume that the company has no excess cash, and that UBT’s investors do not pay personal taxes on interest, dividends, or capital gains.

Financial information for UBT Inc. before Transaction

Share price (in $)                                                                         61.28

Number of shares outstanding (in millions)                                  125

Market value of debt outstanding (in $ millions)                       2,500

Tax Rate (in %)                                                                              35%

  1. What is the enterprise value of UBT Inc. before the proposed transaction (i.e. before the new bond is issued)?

  1. What is the enterprise value of UBT Inc. after the dividend has been paid?

C. What is the share price after the dividend has been paid?

Solutions

Expert Solution

Enterprise value of a company is calculated as = Current Market value of Stock + Preferred stock + Market value of Outstanding debt + Minority interest – Cash and cash equivalents

A. Enterprise Value (EV) before the Transaction:

Market value of Stock = 61.28*125 Mn = 7,660 Mn
Market Value of Outstanding Debt = 2,500 Mn
Preferred Stock and Minority Interest and Cash = 0
Hence EV = 7,660+2,500 = 10,160 Mn

B and C. Enterprise Value (EV) after the Dividend Transaction and Share Price:

Market Value of Stock after Dividend Paid:

Debt of 1,500 Mn paid to 125 Mn shares = 1500/125= $ 12 Dividend/share
Dividend Paid after Tax = 12*(1-0.35)= 7.8
But since the CFO feels the agency benefit of $ 50 Mn = 50/125 = $ 0.4 Benefit/share
Hence Drop in share price due to Dividend Payout = 7.8-0.4=7.4
Share Price after Dividend = 61.28-7.4= $ 53.88

Market value of Stock = 49.68*125 Mn = 6,735 Mn
Fresh Perpetual Debt Issued = 1,500 Mn
Market Value of Outstanding Debt = 4,000 Mn
Preferred Stock and Minority Interest and Cash = 0
Hence EV = 6,735+4,000 = 10,735 Mn

jeff jeffy answered 1 year ago
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