Doubts

Exercise set 8 (part 2), Point c)Exercise 4

Exercise set 8 (part 2), Point c)Exercise 4

by Luca Bassotto -
Number of replies: 1

Dear Professor,

I have a question regarding the last part of the capital structure exercise, specifically the version with taxes and distress costs (where the firm loses €1.2 million in FCF per year and faces a 35% tax rate).

In my calculations, I noticed that the drop in the share price after the debt issuance and equity repurchase seems to match the NPV of the financing decision (−3.25). This led me to wonder:

Can we generally apply this shortcut — subtracting the NPV from the pre-transaction share price — to find the new share price in such cases? Or does it only work when the number of shares repurchased is known?

Thank you for your time and patience.

Best regards,
Luca


In reply to Luca Bassotto

Re: Exercise set 8 (part 2), Point c)Exercise 4

by Julio Crego -
Dear Luca,

Your intuition is correct. If we issue a fixed dollar value of debt, your shortcut always works because the new debt is NPV=0; hence, the equity needs to be lowered as much as the NPV of the leverage recap.