Question

Zetatron is an all-equity firm with 100 million shares outstanding, which are currently trading for $7.50 per share. A month ago, Zetatron announced it will change its capital structure by borrowing $100 million in short-term debt, borrowing $100 million in long-term debt, and issuing $100 million of preferred stock. The $300 million raised by these issues, plus another $50 million in cash that Zetatron already has, will be used to repurchase existing shares of stock. The transaction is scheduled to occur today. Assume perfect capital markets.
Required:
a. What is the market value balance sheet for Zetatron

i. Before this transaction?
ii. After the new securities are issued but before the share repurchase?
iii. After the share repurchase?

b. At the conclusion of this transaction, how many shares outstanding will Zetatron have, and what will the value of those shares be?

Answer 1

Answer:

Zetatron

a. The market value balance sheet for Zetatron:

i. Before this transaction is:

$750 million

ii. After the new securities are issued, but before the share repurchase:

$950 million

iii. After the share repurchase:

$600 million

b.

Number of common shares outstanding after the repurchase = 53.33 million

Value of outstanding shares after recapitalization = $400 million

Explanation:

a) Data and Calculations:

Outstanding shares = 100 million

Current market price = $7.50 per share

Current market capitalization = $7.50 * 100 million = $750 million

b) Capital Restructuring:

Short-term debt = $100 million

Long-term debt = $100 million

Preferred Stock = $100 million

Common Stock = $400 million ($750 - $350)

Market capitalization = $600 million (Long-term, preferred and common stock)

Number of common shares repurchased = 100 million * $350/750 = 46.67 million

Number of common shares outstanding after the repurchase = 53.33 million (100 - 46.67)

Value of outstanding shares after recapitalization = $400 million