Question

Newkirk, Inc., is an unlevered firm with expected annual earnings before taxes of $22.7 million in perpetuity. The current required return on the firm's equity is 15 percent, and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.47 million shares of common stock outstanding and is subject to a corporate tax rate of 40 percent. The firm is planning a recapitalization under which it will issue $31.7 million of perpetual 10.7 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

Part a-1

Current value

$90800000

VU = [(Pretax earnings)(1 – tC)] / R0

VU = [($22700000)(1 – 0.40)] / 0.15

VU = $90800000

Part a-2

Price per share

$61.77

Price per share = $90800000/1470000 = $61.77

Part b-1

Current value

$103480000

NPV = Proceeds – Aftertax PV(Interest Payments)

NPV = $31700000 – ((1 – 0.40)(0.107)($31700000) / 0.107)

NPV = $31700000 - $19020000

NPV =$12680000

Value of the company after the recapitalization using the APV approach:

VU = $90800000 +$12680000 = $103480000

Part b-2

Price per share

$70.39

Price per share = $103480000/1470000 = $70.39

Part c-1

Shares repurchased

450348

Shares repurchased = 31700000/70.39 = 450348

Part c-2

Price per share

$70.40

New shares outstanding = 1470000-450348 = 1019652 shares

New value of equity = 103480000 – 31700000= 71780000

New share price = 71780000/1019652 = $70.40

Part D

Value of the equity

$71777323

RS = R0 + (B/S)(R0 - RB)(1 - TC)

RS = 0.15 + (($31,700,000 / $71780000)(0.15-0.107)(1 -0.4))

RS = 0.15 + 0.0114 = .1614, or 16.14%

NI = (EBIT - Interest)(1 - T)

NI = [$ 22,700,000 - ($31,700,000 x 0.107)](1 - 0.40)

= [$22,700,000 - $3391900](1 – 0.40) = $19308100*(1-0.40) = $11584860

S = Cash flows available to equity holders / RS = $11584860/16.14% = $71777323