Question

Best Bagels, Inc. (BB) currently has zero debt. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. BB's current cost of equity is 13%, and its tax rate is 40%. The firm has 20,000 shares of common stock outstanding selling at a price per share of $23.08. Refer to the data for Best Bagels, Inc. (BB). Now assume that BB is considering changing from its original capital structure to a new capital structure with 45% debt and 55% equity. This results in a weighted average cost of capital equal to 10.4% and a new value of operations of $576,923. Assume BB raises $259,615 in new debt and purchases T-bills to hold until it makes the stock repurchase. BB then sells the T-bills and uses the proceeds to repurchase stock. How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase? a. 12,711; $35.62 b. 11,001; $28.85 c. 17,105; $89.67 d. 15,220; $54.31

Answer 1

b. 11,001; $28.85

Step-by-step explanation:

EBIT $100,000

zero growth rate

Cost of equity (Re) 13%

tax rate 40%

20,000 common stocks outstanding at $23.08

they want to change from 100% equity to 45% debt and 55% equity

WACC = 10.4%

new value of operations $576,923

PP's value of operations = {$100,000 x (1 - 40%)} / WACC = $576,923

the new stock price should = $576,923 / 20,000 stocks = $28.84615

Stock price will be $28.846

approximately $259,615 / $28.846 = 8,999 stocks should be repurchased

number of stocks remaining after the repurchase = 20,000 - 8,999 = 11,001

total capitalization = $317,308 / 11,001 stocks = $28.84 ≈ $28.85 per stock