Essay About Total Value And Open Market

An Introduction to Debt Policy and Value
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
unknowns—share 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: