The CFO is planning borrow $3M to buy back shares from investors. The bank will be charging 7%pa on these funds.

Current Proposed
Debt $0
Interest $0
Equity $8M
# of shares 185Thousand
Price per share
Debt + Equity

Calculate the value of equity in the proposed structure.

Question

The CFO is planning borrow $3M to buy back shares from investors.  The bank will be charging 7%pa on these funds.

Current	Proposed
Debt	$0	
Interest	$0	
Equity	$8M	
# of shares	185Thousand	
Price per share		
Debt + Equity

Calculate the value of equity in the proposed structure.

BlackTom AI · Accepted Answer

We start with the provided balance information: Current equity is $8,000,000 and debt is $0. The proposal involves borrowing $3,000,000 at 7% per year to fund a buyback of shares.

Step 1: Show the cash flow impact of the debt and the buyback. The bank loan increases cash by $3,000,000. The share repurchase uses $3,000,000 of cash to buy back shares from investors. Net effect on cash is zero, since the cash coming in from debt is exactly used to finance the buyback.

Step 2: Effect on equity. A share buyback reduces equity by the amount spent on repurchasing shares (treasury stock). Here, $3,000,000 of equity is reduced due to the buyback.

Step 3: Determine new debt and new equity. After the transaction, debt rises to $3,000,000 (the borrowed funds). Equity is reduced from $8,000,000 by $3,000,000, giving $5,000,000 of remaining equity.

Step 4: Sanity check. The basic accounting identity remains Assets = Liabilities + Equity. The assets temporarily rise by the loan amount and then fall by the same amount when the buyback occurs, so total assets end up consistent with the new liabilities and reduced equity. Since the question asks for the value of equity in the proposed structure, the resulting figure is $5,000,000.

Note on missing options: If there were multiple-choice options, we would compare each option to the calculation above and justify why it matches (or does not match) the computed equity of $5,000,000. If any loan costs or interest are relevant to value over time, they would affect net income and cash flows, but not the immediate equity balance in this simplified balance-sheet view at the inception of the structure.

BFIN011 Week 10: Practice Quiz

The CFO is planning borrow $3M to buy back shares from investors. The bank will be charging 7%pa on these funds. Current Proposed Debt $0 Interest $0 Equity $8M # of shares 185Thousand Price per share Debt + Equity Calculate the value of equity in the proposed structure.

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Similar Questions

Which of the following statements best reflects the key insight of the M&M Proposition (without taxes)?

In a world with perfect capital markets, a firm that issues a large amount debt to finance a share repurchase will ultimately boost its EPS and reduce its post-transaction market capitalization, but will not affect its stock price.

In a world with corporate taxes (only capital markets imperfection), a levered firm will issue equity to repay some of its debt. Indicate which of the following statements is correct:

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