assume that VF is considering changing from its original zero debt capital structure to a new capital structure with even more debt.This results in changes in the cost of debt and equity, and thus to a new WACC and a new value of operations.Assume VF raises the amount of new debt indicated below and uses the funds to purchase and hold T-bills until it makes the stock repurchase.What is the stock price per share immediately after issuing the debt but prior to the repurchase?
EBIT =$80,000
New Debt/Value =20%
Growth =0%
New Equity/Value =80%
Orig cost of equity, rs =10.0%
No. of shares =10,000
New cost of equity = rs =11.0%
Price per share =$48.00
Tax rate =40%
Interest rate = rd =7.0%
A)$50.67
B)$53.33
C)$56.00
D)$58.80
E)$61.74

Question

Quizplus · Accepted Answer

First, we need to calculate the new cost of debt using the formula:

After-tax cost of debt = rd(1 - T)
After-tax cost of debt = 0.07(1 - 0.4)
After-tax cost of debt = 0.042 or 4.2%

Next, we need to calculate the new WACC using the formula:

WACC = (E/V) * rs + (D/V) * rd * (1 - T)

Where:
E = market value of equity
D = market value of debt
V = E + D

We can use the information given to calculate the market values of equity and debt:

Market value of equity = 10,000 shares * $48.00 per share
Market value of equity = $480,000

Market value of debt = ($480,000 / 0.8) * 0.2
Market value of debt = $60,000

Now we can calculate the new WACC:

WACC = (0.8) * 0.11 + (0.2) * 0.042 * (1 - 0.4)
WACC = 0.0884 or 8.84%

Finally, we can use the WACC to calculate the new value of the company:

V = E/0.8 = $480,000/0.8 = $600,000

The amount of new debt is not given, but this is not needed to calculate the stock price. Instead, we can use the formula for the value of operations:

Vop = EBIT / WACC

Vop = $80,000 / 0.0884
Vop = $904,977.38

To calculate the stock price, we subtract the market value of debt from the total value of the company and divide by the number of shares:

Stock price = ($600,000 - $60,000) / 10,000
Stock price = $54.00

However, this is the value immediately after issuing the debt, so we need to adjust for the interest earned on the T-bills. Since the growth rate is 0%, this is simply the interest rate on the T-bills, which is not given. We can assume that it is equal to the cost of debt, which is 7%. If VF uses all of the new debt to purchase T-bills, it will earn 7% on $60,000, or $4,200. We can divide this by the number of shares to get the per-share adjustment:

Per-share adjustment = $4,200 / 10,000
Per-share adjustment = $0.42

Therefore, the final stock price is $54.00 + $0.42 = $54.42, which is closest to answer choice B ($53.33).

Assume That VF Is Considering Changing from Its Original Zero