Question

Newkirk, Inc., is an unlevered firm with expected annual earnings before taxes of $21.7 million in perpetuity. The current required return on the firm’s equity is 16 percent, and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.37 million shares of common stock outstanding and is subject to a corporate tax rate of 35 percent. The firm is planning a recapitalization under which it will issue $30.7 million of perpetual 9.7 percent debt and use the proceeds to buy back shares. a-1. Calculate the value of the company before the recapitalization plan is announced. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)      Current value $        a-2. What is the price per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)      Price per share $       b-1. Use the APV method to calculate the company value after the recapitalization plan is announced. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)      Value after recapitalization $       b-2. What is the price per share after the recapitalization is announced? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)      Price per share $         c-1. How many shares will be repurchased? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)      Shares repurchased       c-2. What is the price per share after the recapitalization and repurchase? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)       Price per share $        d. Use the flow to equity method to calculate the value of the company’s equity after the recapitalization. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)      Value of the equity $

Answer 1

a) calculation of value of equity:-

The interest payment for each year is = 87,500 × 10%. = 8,750

Which is exactly equal to the EBIT.so, no cash available to the equity shareholders.

Under this situation,

Value of equity = 0

a-2) calculation of debt to value ratio:-

Market value of debt = 87,500.

Value of firm = market value of debt + market value of equity

Value of firm= 87,500+0

= 87,500

Debt to value ratio =( debt/ value of firm)× 100

=(87,500/87500)× 100

Debt to value ratio =100%

B) AT Growth rate 2%

Earning = 8750 × (1.02) = 8,925.

Cash available to shareholders= 8925-8750= 175

Market value of equity = 175/(0.1-0.02) = 2,187.5

Debt to value ratio = [87,500/(87,500+2,187.5)]× 100

=97.561%.

C)Growth rate at 4%

Earnings= 8750 × 1.04 = 9100

Cash available to shareholders= 9100-8750 =350

Market value of equity =350/(0.1-0.04) = 5,833.33

Value of firm = 87,500+5833.333 = 93,333.333

Debt to value ratio = (87,500/93,333.333)× 100

=93.75%