Effect of capital structure on companies value per share.
As a way of illustrating the usefulness of the M&M theory and consolidating your grasp of the mechanics, consider the following case and complete the worksheet. On March 3, 1988, Beazer PLC (a British construction company) and Shearson Lehmen Hutton, Inc. (an investment-banking firm) commenced a hostile tender offer to purchase all the outstanding stock of Koppers Company, Inc., a producer of construction materials, chemicals, and building products. Originally, the raiders offered $45 a share: subsequently, the offer was raised to $56 and then finally to $61 a share. The Koppers board asserted that the offers were inadequate and its management was reviewing the possibility of a major recapitalization.
To test the valuation effects of the recapitalization alternative, assume that Koppers could borrow a maximum of $1,738,095,000 at a pretax cost of debt of 10.5 percent and that the aggregate amount of debt will remain constant in perpetuity. Thus, Koppers will take on additional debt of $1,565,686,000 (that is, $1,738,095,000 minus $172,409,000). Also assume that the proceeds of the loan would be paid as an extraordinary dividend to shareholders. Exhibit 1 presents Koppers' book- and market-value balance sheets, assuming the capital structure before recapitalization. Please complete the worksheet for the recapitalization alternative.
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EXHIBIT Koppers Company, Inc. (values in thousands)
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Before Recapitalization
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Bock-Value Balance Sheets
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Net working capital
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$212,453
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Fixed assets
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601,446
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Total assets
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$813,899
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Long-term debt
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$172,409
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Deferred taxes, etc.
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195,616
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Preferred stock
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15,000
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Common equity
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430,874
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Total capital
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$813,899
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Market-Value Balance Sheets
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Net working capital
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$212,453
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Fixed assets
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1,618,081
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Present value (PV) debt tax shield
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58,619
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Total assets
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$1,889,153
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Long-term debt
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$172,409
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Deferred taxes, etc.
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0
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Preferred stock
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15,000
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Common equity
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1,701,744
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Total capital
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$1,889,153
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Number of shares
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28,128
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