Question

Firms use recapitalization for different reasons. Recapitalization is the process through which firms make desired changes in their capital structure by using debt to repurchase equity. Firms may decide to recapitalize for various reasons, such as to maintain an optimal capital structure, to use as a defense mechanism against a hostile takeover, to minimize taxes, or to use in an exit strategy for venture capitalists.

As an analyst, you are tracking the financial performance of Maclaren and Tray Corp. (M&T) The company has been 100% equity owned but recently made changes to its capital structure. You have collected the following information about the recapitalization: • M&T issued $24,500,000 in new debt to buy back stock. • The firm had no short-term investments before or after the recapitalization.
• M&T had 1,750,000 shares outstanding before the recapitalization. • M&T’s capital structure now has 35% debt. • The company’s operations are valued at $70 million after recapitalization.
Based on the information available, solve for the values in the following table. Click on the dropdown menus and then select the best answer. Assume that you are in a Modigliani and Miller (M&M) world with no taxes.
Value Stock price before the repurchase 40,140,52, or 44
Number of shares repurchased 612,500; 1,225,000; 918,750; 700,000
Value of equity post repurchase 36.40; 45.50; 31.85; 22.75
Based on your analysis, you prepared a report with several inferences.
While proofreading, you come across the following inference.
Consider this case: Recapitalization might increase the EPS, but the price per share remains the same. Is the statement true or false? True False

Answer 1

Recapitalization might increase the EPS, but the statement that the price per share remains the same is false.

Step-by-step explanation:

In this case, the statement is False. Recapitalization may lead to an increase in earnings per share (EPS), but it can also impact the price per share. When a firm uses debt to repurchase equity, it reduces the number of outstanding shares. This reduction in shares can result in an increase in EPS because the same earnings are divided by a smaller number of shares. However, the price per share may not remain the same as recapitalization could influence investor perception of the company's financial health or future prospects.

Answer 2

Firms raise financial capital through various sources such as early-stage investors, reinvesting profits, loans, and issuing stock. Recapitalization involves changing the capital structure, as seen with M&T, which affects metrics like EPS and stock price. The statement about EPS increasing while the stock price remains the same in a no-tax M&M world is false.

Step-by-step explanation:

Firms use various methods to raise financial capital necessary to fund long-term investments such as purchasing machinery, building new facilities, or initiating research and development projects. These methods include acquiring funds from early-stage investors, reinvesting profits, borrowing from banks or through bonds, and selling stock in the company. The decision about which source of capital to use is strategic and influences future obligations, such as interest payments on debt and dividends to shareholders.

In cases where a company like Maclaren and Tray Corp. (M&T) decides to recapitalize, it undertakes issuing new debt to repurchase equity. This changes the firm's capital structure, potentially optimizing it for future operations. M&T's recent recapitalization involved issuing new debt to reduce its outstanding shares, which affects various financial metrics including earnings per share (EPS) and the price per share.

Regarding the statement in the proofreading task, in an M&M world with no taxes, the presentation of recapitalization affecting EPS but not the price per share is false. Recapitalization impacts the company's leverage and can change both EPS and the stock price, depending on various market factors and investor perceptions.