Derek's Dinghies and Rafts (DDR)is the World's Largest Manufacturer of Rowboats

question 52

Multiple Choice

Derek's Dinghies and Rafts (DDR) is the world's largest manufacturer of rowboats and rafts.At the end of the current year,analysts expect DDR's EBIT to be $2M and they expect the same earnings annually in perpetuity.DDR's shareholders require a return of 12.5% and there are 5M common shares outstanding.DDR has debt with a total face value of $5M.The bonds have an annual coupon of 3%,are rated AAA and yield 3%.The CFO of DDR believes that the company is under-levered.To increase the leverage,the CFO proposes to repurchase 1.2M shares at a price of $1.25 per share.The repurchase will be financed by additional borrowing.The corporate tax rate is 40%.What is the value of the company prior to the repurchase,and what is the stock price after the repurchase?

• A) Value (prior) = $9.6M; Stock price (after) = $1.50
• B) Value (prior) = $9.6M; Stock price (after) = $1.14
• C) Value (prior) = $11.6M; Stock price (after) = $1.50
• D) Value (prior) = $11.6M; Stock price (after) = $1.14
• E) Value (prior) = $11.6M; Stock price (after) = $3.21

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Definitions:

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Placebo Effect

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