Question

Please show calculation

Global Pistons (GP) has common stock with a market value of $310 million and debt with a value of $231 million. Investors expect a 15% return on the stock and a 9% return on the debt. Assume perfect capital markets. a. Suppose GP issues $231 million of new stock to buy back the debt. What is the expected return of the stock after this transaction? b. Suppose instead GP issues $61.73 million of new debt to repurchase stock. i. If the risk of the debt does not change, what is the expected return of the stock after this transaction? ii. If the risk of the debt increases, would the expected return of the stock be higher or lower than when debt is issued to repurchase stock in part (0)?

Answer 1

a common stock with a market valuez & 3 fom . (oldequity) value of debt (new equity) - $ 2310 Total Equiry $541m weight of old equity weight of newequiry = 310m - 0.573 20.57 - 231m. 0.42720:43 suim suim Total weight :1:00 : 1000 weighted Refur not, 0.57X1S- 8.554 old equity M12 New Equity's weighted reform: 0143894, 3.87" - 12421/. Expected return of the stock after this transaction is equal to G.P'S WACC, that shall not be changed.

for Suppose instead GP issues $61.73m of new debt to repurchase stocle 1) New walce of Equity - Blom -61.73 - 2018.271 new value of debt - 231m +61-73 · 292.73m Repureloje shock - Debt - 292.43=1179 Equity 248.27 $1.18

from the above calculations WACC = 12.42./. Debt Equity : 1.18 cost of debt -94, Expected Return's' = 12.427.7 .18 (12:421-911,5 : 12:42').+ 4.0356 a 16.4556 - 16:4614

bii) The debt will share some of equity's risk. If the risk of the debt increases, the expected return of the shock would be lower than when debt is issued to repurchase the stocle in part (i).