Question

Zoom Corporation currently has a share price of $12.50 and $50 million in cash. The firm has 20 million shares outstanding and no debt. Suppose Zoom wants to use all of its cash to repurchase shares. After the share repurchase, news will come out that will change Zoom's Enterprise Value to either $300 million or $100 million.

a) What will Zoom's share price be in case the enterprise value goes up? What will Zoom's share price be in case the enterprise value declines? (Hint: Rememberthat the news will come out afterthe share repurchase. Remember that Enterprise Value = Equity + Debt –Cash)

Answer 1

After Zoom Corporation uses its $50 million in cash to repurchase shares, if the enterprise value rises to $300 million, the new share price would be $18.75. Conversely, if the enterprise value declines to $100 million, the new share price would drop to $6.25.

Step-by-step explanation:

To determine the share price of Zoom Corporation after share repurchase if the enterprise value changes, we first need to calculate the new number of shares outstanding post-repurchase. If Zoom uses all of its $50 million cash to buy back shares at the current price of $12.50, it can repurchase 4 million shares ($50 million / $12.50 per share). This will leave Zoom with 16 million shares outstanding (20 million original - 4 million repurchased).

Now, post-repurchase, if Zoom's enterprise value goes up to $300 million, we calculate the new equity value by adding cash (which is now $0, since it was used for the repurchase) and subtracting any debt (which is $0 as given). So, the equity value will be equal to the enterprise value of $300 million. The new share price will then be $300 million / 16 million shares = $18.75 per share.

In the case where the enterprise value declines to $100 million, using the same method, the new equity value is also $100 million and the new share price would be $100 million / 16 million shares = $6.25 per share.