4. What remains to be seen however, is whether shareholders are better or worse off with more leverage. Problem 2 does

not tell us, because there we computed total value of equity, and shareholders care about value per share. Ordinarily,

total value will be a good proxy for what is happening to the price per share, but in the case of a relevering firm, that may

not be true. Implicitly we assumed that, as our firm in problems 1-3 levered up, it was repurchasing stock on the open market

(you will note that EBIT did not change, so management was clearly not investing the proceeds from the loans in

cash-generating assets). We held EBIT constant so that we could see clearly the effect of financial changes without

getting them mixed up in the effects of investments. The point is that, as the firm borrows and repurchases shares, the

total value of equity may decline, but the price per share may rise.

Now, solving for the price per share may seem impossible, because we are dealing with two unknownsshare price and

change in the number of shares:

Share Total Market

Price = Value of Equity

(Original - Repurchased

Shares Shares)

But by rewriting the equation, we can put it in a form that can be solved:

Share Total Market Cash

Price = Value of Equity + Paid Out

# Original Shares

Referring to the results of problem 2, let's assume that all the new debt is equal to the cash paid to repurchase shares.

Please complete the following table:

0% Debt/

25% Debt/

50% Debt/

100% Equity

75% Equity

50% Equity

Total Market Value of Equity (from Prob. 2) (this is like E1)

Cash Paid Out (to buy back shares) (this is like D1)

# Original Shares

1000

1000

1000

Total Value Per Share

Number of shares repurchased

Number of shares outstanding