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Newkirk, Inc
Newkirk, Inc., is an unlevered firm with expected annual earnings before taxes of $21.9 million in perpetuity. The current required return on the firm's equity is 18 percent, and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.39 million shares of common stock outstanding and is subject to a corporate tax rate of 34 percent. The firm is planning a recapitalization under which it will issue $30.9 million of perpetual 9.9 percent debt and use the proceeds to buy back shares.
a-1.Calculate the value of the company before the recapitalization plan is announced. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
Current value
a-2.What is the price per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Price per share
b-1.Use the APV method to calculate the company value after the recapitalization plan is announced. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
Value after recapitalization
b-2.What is the price per share after the recapitalization is announced? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Price per share
c-1.How many shares will be repurchased? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
Shares repurchased
c-2. What is the price per share after the recapitalization and repurchase? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Price per share$
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
Expert Solution
a-1). Computation of the current value:-
Current value = EBT*(1-Tax rate)/ Cost of equity
= $21,900,000*(1-34%)/18%
= $80,300,000
a-2). Computation of the price per share:-
Price per share = Value of before capitalization / Number of outstanding shares
= $80,300,000 / 1,390,000
= $57.77 per share
b-1). Computation of the value of after recapitalization:-
PV of tax benefit = Interest expense * Tax rate / Cost of debt
= ($30,900,000*9.9%)*34%/9.9%
= $10,506,000
Value of after recapitalization = Value of before capitalization + PV of tax benefit
= $80,300,000 + $10,506,000
= $90,806,000
b-2). Computation of the price per share:-
Price per share = Value of after capitalization / Number of outstanding shares
= $90,806,000 / 1,390,000
= $65.33 per share
c-1). Computation of the number of shares repurchased:-
Number of shares repurchased = Total debt value / Price per share
= $30,900,000 / $65.33
= 472,997.38 Or 472,997 shares
c-2). Computation of the price per share:-
Number of shares outstanding after recapitalization and repurchase = 1,390,000 - 472,997
= 917,002 shares
New value of equity = $90,806,000 - $30,900,000
= $59,906,000
Price per share = New value of equity/ Number of shares
= $59,906,000 / 917,002
= $65.33 per share
d). Computation of the value of equity:-
Required return on levered equity = Cost of equity + ((Cost of equity - Cost of debt)*(D/E ratio)*(1-Tax rate))
= 18%+((18%-9.9%)*(30900000/59906000)*(1-34%))
= 18%+(8.1%*0.52*66%)
= 18%+2.76%
= 20.76%
Net income = (EBT - Interest Expense) * (1 - tax rate)
= ($21,900,000-($30,900,000*9.9%))*(1-34%)
= ($21,900,000-$3,059,000)*66%
= $18,840,900*66%
= $12,434,994
Value of equity = Net income / Required return on levered equity
= $12,434,994 / 20.76%
= $59,906,000
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