Question

Abdul owns 200 shares of Intec Corp. stock. The firm is currently an all equity firm with a market value of $42,000,000 and 1,500,000 shares outstanding. Management of the firm is thinking of borrowing 20% of the current value of the firm and buying back shares with the funds. Even if management goes through with the proposed capital structure change, Abdul will keep all of his shares. There are no taxes or other market imperfections.

4. In numbers, what must Abdul do if the firm goes through with the recapitalization but Abdul wanted the cash flows from the firm as it is currently capitalized? Show your work.

Answer 1

Market Value	42,000,000.00
Shares Outstanding	1,500,000.00
Value per share	28.00
(42000000/1500000)
20% of market value	8,400,000
No of shares after buyback	1,200,000
Firm now has a debt equity ratio of 80:20 or 4:1
To earn the same cashflow from firm as it is cpitalised , Abdul will have to sell 20% of his stock and invest it in risk free security
Shares Abdul owns	200
20% of shares	40
Value of shares to be sold (40*28)	1120