CFA Level I · CFA Level I Exam · Capital Structure
A firm has 50 million shares at 20 each and no debt. It announces a debt-financed repurchase of 10 million shares at 20 each, borrowing 200 million. Investors read this as a signal that managers expect stable, strong future cash flows. Ignoring taxes and other effects, if the signal is believed and the market value of the firm's operations rises by 5%, the post-repurchase share price is closest to:
The post-repurchase price is about 21.25. Firm value rises 5% from 1,000 million to 1,050 million, the 200 million of new debt is deducted to leave equity of 850 million, and dividing by the 40 million remaining shares gives 21.25 per share.
- A20.00
- B21.25Correct
- C26.25
Explanation
Initial firm value is 50m x 20 = 1,000m. A 5% rise gives 1,050m. Subtract new debt of 200m to get equity of 850m. Divide by the remaining 40m shares: 850/40 = 21.25. Failing to deduct the debt gives 1,050/40 = 26.25, which is wrong; 20.00 ignores the signal.
Did you get it right without looking?
One question tells you little. A timed set on Capital Structure shows your real accuracy, how long you take and where you lose marks.
More Capital Structure questions
- Compared with the static trade-off theory's prediction at the optimal capital structure, a firm that has raised debt well beyond that optimu…
- A firm has a marginal tax rate of 25% and currently has debt of 400 at a 6% interest rate. Under the static trade-off theory, the firm's ann…
- According to static trade-off theory, beyond the optimal debt level, an additional unit of debt most likely:
- According to the static trade-off theory of capital structure, the optimal level of debt for a firm is most likely reached at the point wher…
- According to Modigliani-Miller Proposition I without taxes, a firm's value is most likely:
- According to the static trade-off theory of capital structure, as a firm increases its debt beyond the optimal level, the marginal benefit o…