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    5. Based on the foregoing problem, suppose that Foxtrot dance Shoes makes custom designed dance shoes and is a competitor to Tango Dance Shoes. Foxtrot has similar risks and characteristics as Tango except that it is completely unlevered. Fearful that Tango Dance Shoes may try to take over Foxtrot in order to control its niche in the market, Foxtrot decides to lever the firm to buy back stock.

    a. If there are currently 500,000 shares outstanding, what is the value of Foxtrot's stock?
    b. How many shares can Foxtrot buy back and at what value if it is wiling to borrow 30% of the value of the firm?
    c. What if it is willing to borrow 40% of the value of the firm?
    d. Should Foxtrot borrow more?

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    Solution Preview

    Please see the attached file.


    a. Current price per share:

    $13.125 million /.5 million shares = $26.25 per share

    b. @30% debt

    Amount to borrow: 30% of 13.125 million = $3.9375 million
    PV of Tax Shield = .4 x $3.9375 million = $1.575 million
    Value of levered firm = $13.125 + $1.575 = $14.7 million
    Value of equity in levered firm = $14.7 million - $3.9375 million = $10.7625 million

    To compute the number of shares Foxtrot can repurchase, we need to know the price per share.

    If Foxtrot can repurchase shares at the existing price of $26.25 then the number of ...

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