Current stock price = (assets-debt)/shares outstanding
Shareprice after dividend paid = (assets-debt-cash(div))/shares outstanding
Shareprice after share repurchase: E/new shares outstanding
1. E = market value of assets – debt – cash (dividend)
2. shares outstanding =
- repurchased shares = cash(div)/price per share of current stock price
- new nr. Of shares outstanding = original nr. Of shares outstanding – repurchased shares
New D/E ratio after either transaction:
1. D/E ratio = debt/new equity value
- new equity value = market value of assets – debt – cash(div)
Ex-dividend shareprice in perfect capital market
1. dividend payoff = cash/shares outstanding
2. ex dividend price = current market price – dividend payoff
In perfect market, price of share remains same after repurchase
In perfect market, value of firm same under either policy
Board considering selling treasuries and paying out proceeds as one-time dividend, if board went ahead with this plan, what would happen to value
of kay industries upon announcement of a change in policy?
The value of kay would remain the same, (because perfect capital market?)
What would happen to value of kay industries on ex-dividend date of one-time dividend?
Would fall by 100 mil which is invested
Given these price reactions, will this decision benefit investors? It will neither benefit nor hurt investors
Shareprice prior to share repurchase with enterprise value = value of the firm/shares outstanding
- EV for value of the firm: EV = equity + debt – cash
- equity value (value firm) = EV + cash – debt
- shareprice = equity value.shares outstanding (=price per share)
Shareprice after repurchase if enterprise value goes up:
1. shares = excess cash/price per share (see above)
2. remaining shares outstanding = old shares outstanding – shares
3. shareprice if EV goes up to 600 mil: 600(=increase)/remaining shares outstanding
Shareprice if EV goes down to 200 mil: 200(=decrease)/remaining shares outstanding
Company waits until after news comes out to do share repurchase, what is shareprice after repurchase if EV goes up:
If goes up:
1. (rise prior to repurchase+cash)/shares outstanding
If falls:
2. (decline prior to repurchase+cash)/shares outstanding
Suppose management expects good news to come out. Based on answers in b and c, if management desires to maximize company’s ultimate share
price, will they undertake the repurchase before or after the news comes out, when would management undertake repurchase if they expect bad
news to come out?
If management expects good news to come out, they would prefer to do the repurchase first, so that the stock price would rise to 75 rather than
70. On other hand, if they expect bad news to come out, they would prefer to do repurchase after news comes out, for stock price of 30 rather than
25. (intuitively, management prefers to do repurchase if stock is undervalued, they expect good news to come out, but not when overvalued
because they expect bad news to come out)
Given on answer d, what effect would you expect an announcement of a share repurchase to have on the stock price?
We expect managers to do a share repurchase before good news comes out and after any bad news has already come out. Therefore, if ivnestors
believe managers are better informed about the firm’s future prospects, and that they are timing their share repurchases accordingly, a share
repurchase announcement would lead to an increase in the stock price.
How much debt if maintain constant D/E ratio?
Time 0: (not given but can write down)
1. market value of equity = nr. Of shares outstanding*price per share
2. D/E ratio = debt/market value of equity
Time 3:
3. market value of equity = nr of shares outstanding*price per share
4. D/E ratio: unknown debt/market value of equity = D/E ratio time 0 (set equal)
5. unknown debt = D/E ratio time 0*market value of equity time 3
In 2006, intel corporation had a market capitalization of $134 billion, debt of $13.2 billion, cash of 13.8 billion and ebit of more than 16 billion. If
intel were to increase its debt by 1 billion and use the cash for a share repurchase, which market imperfections would be most relevant for
understanding the consequence for intel’s value?
- intel’s debt is a tiny fraction of its total value. Indeed, intel has more cash than debt, so its net debt is negative. Intel is also very profitable; at an
interest rate of 6%, interest on Intel’s debt is only $792 mil per year, which is 4.95% of its ebit, thus the risk that intel will default on its debt is
extremely small. This risk will remain extremely small even if intel borrows additional 1 billion.
, - thus, adding debt will not really change likelihood of financial distress (=cannot generate sufficient revenues/income) for Intel (nearly 0), and thus
will also not lead to agency conflicts. As result, most important financial friction for such a debt increase is the tax savings intel would receive from
the interest tax shield. A secondary issue may be the signaling impact of the transaction – borrowing to do a share repurchase is usually interpreted
as a positive. Management may views the shares to be underpriced
What aftertax amount must it receive for the plant for divesture to be profitable?
1. WACC = E/E+D*re+D/(E+D)*rd*(1-t)
2. V levered = FCF/(rwacc-g)
What constant expected growth rate of FCF Is consistent with its current stock price?
1. E = price per share*shares outstanding
2. D = D/E ratio*E
3. vL = E + D
4. from CAPM: equity cost of capital = rf+Be*(rm-rf)
5. wacc = (E/D+E)*re+(D/D+E)*rd*(1-t)
6. vL = FCF/(rwacc-g) -> g=rwacc-FCF/vL
vL was already calculated in 3, so you can fill that in, only thing that you need to find is g
determine the increase in the stock price that would result from the anticipated tax savings: (increasing debt though leveraged recap)
1. initial unlevered cost of capital = rU = E/E+D)*re+(D/D+E)*rd
2. new equity cost of capital (re) = ru + D/E*(ru-new rd)
3. new wacc (use D/E ratio) = (E/E+D)*re+ (D/E+D)*rd*(1=-)
4. vL = FCF/(new wacc – g)
5. gain: new vL – old vL
6. price per share = gain/shares outstanding,
7 share price rises to: old price per share + new price per share
The current price of estelle corporation stock is $25. In the next year the stock price will either go up by 20% or go down by 20%. The stock pays no
dividends. To one-year risk-free rate is 6% and will remain constant.
Using binomial model, calculate price of one-year call option on Estelle stock with strike price of 25
1. stock price either rises to Su=25*1.20=30 or falls to Sd=25*0.8=20
2. option payoff therefore either Cu=5 or Cd=0
3. replicating portfolio Is D = (5-0)/(30-20) = 0.5 which is delta
4. B = (0-20*0.5)/1.06 = -9.43
5. C = 0.5*25-9.43 = $3.07
Using binomial model, calculate price of one-year put option on Estelle stock with strike price of 25
1. option payiff of put is Cu=0 or Cd=5
2. replicating portfolio is D = (0-5)/(30-20) = -0.5
3. B = (5-20*(-0.5))/1.06 = 14.15
4. P = -0.5*25+14.15 = 1.65
Shareprice after dividend paid = (assets-debt-cash(div))/shares outstanding
Shareprice after share repurchase: E/new shares outstanding
1. E = market value of assets – debt – cash (dividend)
2. shares outstanding =
- repurchased shares = cash(div)/price per share of current stock price
- new nr. Of shares outstanding = original nr. Of shares outstanding – repurchased shares
New D/E ratio after either transaction:
1. D/E ratio = debt/new equity value
- new equity value = market value of assets – debt – cash(div)
Ex-dividend shareprice in perfect capital market
1. dividend payoff = cash/shares outstanding
2. ex dividend price = current market price – dividend payoff
In perfect market, price of share remains same after repurchase
In perfect market, value of firm same under either policy
Board considering selling treasuries and paying out proceeds as one-time dividend, if board went ahead with this plan, what would happen to value
of kay industries upon announcement of a change in policy?
The value of kay would remain the same, (because perfect capital market?)
What would happen to value of kay industries on ex-dividend date of one-time dividend?
Would fall by 100 mil which is invested
Given these price reactions, will this decision benefit investors? It will neither benefit nor hurt investors
Shareprice prior to share repurchase with enterprise value = value of the firm/shares outstanding
- EV for value of the firm: EV = equity + debt – cash
- equity value (value firm) = EV + cash – debt
- shareprice = equity value.shares outstanding (=price per share)
Shareprice after repurchase if enterprise value goes up:
1. shares = excess cash/price per share (see above)
2. remaining shares outstanding = old shares outstanding – shares
3. shareprice if EV goes up to 600 mil: 600(=increase)/remaining shares outstanding
Shareprice if EV goes down to 200 mil: 200(=decrease)/remaining shares outstanding
Company waits until after news comes out to do share repurchase, what is shareprice after repurchase if EV goes up:
If goes up:
1. (rise prior to repurchase+cash)/shares outstanding
If falls:
2. (decline prior to repurchase+cash)/shares outstanding
Suppose management expects good news to come out. Based on answers in b and c, if management desires to maximize company’s ultimate share
price, will they undertake the repurchase before or after the news comes out, when would management undertake repurchase if they expect bad
news to come out?
If management expects good news to come out, they would prefer to do the repurchase first, so that the stock price would rise to 75 rather than
70. On other hand, if they expect bad news to come out, they would prefer to do repurchase after news comes out, for stock price of 30 rather than
25. (intuitively, management prefers to do repurchase if stock is undervalued, they expect good news to come out, but not when overvalued
because they expect bad news to come out)
Given on answer d, what effect would you expect an announcement of a share repurchase to have on the stock price?
We expect managers to do a share repurchase before good news comes out and after any bad news has already come out. Therefore, if ivnestors
believe managers are better informed about the firm’s future prospects, and that they are timing their share repurchases accordingly, a share
repurchase announcement would lead to an increase in the stock price.
How much debt if maintain constant D/E ratio?
Time 0: (not given but can write down)
1. market value of equity = nr. Of shares outstanding*price per share
2. D/E ratio = debt/market value of equity
Time 3:
3. market value of equity = nr of shares outstanding*price per share
4. D/E ratio: unknown debt/market value of equity = D/E ratio time 0 (set equal)
5. unknown debt = D/E ratio time 0*market value of equity time 3
In 2006, intel corporation had a market capitalization of $134 billion, debt of $13.2 billion, cash of 13.8 billion and ebit of more than 16 billion. If
intel were to increase its debt by 1 billion and use the cash for a share repurchase, which market imperfections would be most relevant for
understanding the consequence for intel’s value?
- intel’s debt is a tiny fraction of its total value. Indeed, intel has more cash than debt, so its net debt is negative. Intel is also very profitable; at an
interest rate of 6%, interest on Intel’s debt is only $792 mil per year, which is 4.95% of its ebit, thus the risk that intel will default on its debt is
extremely small. This risk will remain extremely small even if intel borrows additional 1 billion.
, - thus, adding debt will not really change likelihood of financial distress (=cannot generate sufficient revenues/income) for Intel (nearly 0), and thus
will also not lead to agency conflicts. As result, most important financial friction for such a debt increase is the tax savings intel would receive from
the interest tax shield. A secondary issue may be the signaling impact of the transaction – borrowing to do a share repurchase is usually interpreted
as a positive. Management may views the shares to be underpriced
What aftertax amount must it receive for the plant for divesture to be profitable?
1. WACC = E/E+D*re+D/(E+D)*rd*(1-t)
2. V levered = FCF/(rwacc-g)
What constant expected growth rate of FCF Is consistent with its current stock price?
1. E = price per share*shares outstanding
2. D = D/E ratio*E
3. vL = E + D
4. from CAPM: equity cost of capital = rf+Be*(rm-rf)
5. wacc = (E/D+E)*re+(D/D+E)*rd*(1-t)
6. vL = FCF/(rwacc-g) -> g=rwacc-FCF/vL
vL was already calculated in 3, so you can fill that in, only thing that you need to find is g
determine the increase in the stock price that would result from the anticipated tax savings: (increasing debt though leveraged recap)
1. initial unlevered cost of capital = rU = E/E+D)*re+(D/D+E)*rd
2. new equity cost of capital (re) = ru + D/E*(ru-new rd)
3. new wacc (use D/E ratio) = (E/E+D)*re+ (D/E+D)*rd*(1=-)
4. vL = FCF/(new wacc – g)
5. gain: new vL – old vL
6. price per share = gain/shares outstanding,
7 share price rises to: old price per share + new price per share
The current price of estelle corporation stock is $25. In the next year the stock price will either go up by 20% or go down by 20%. The stock pays no
dividends. To one-year risk-free rate is 6% and will remain constant.
Using binomial model, calculate price of one-year call option on Estelle stock with strike price of 25
1. stock price either rises to Su=25*1.20=30 or falls to Sd=25*0.8=20
2. option payoff therefore either Cu=5 or Cd=0
3. replicating portfolio Is D = (5-0)/(30-20) = 0.5 which is delta
4. B = (0-20*0.5)/1.06 = -9.43
5. C = 0.5*25-9.43 = $3.07
Using binomial model, calculate price of one-year put option on Estelle stock with strike price of 25
1. option payiff of put is Cu=0 or Cd=5
2. replicating portfolio is D = (0-5)/(30-20) = -0.5
3. B = (5-20*(-0.5))/1.06 = 14.15
4. P = -0.5*25+14.15 = 1.65
