Lanley Monorails Inc. is all equity financed and generates perpetual annual EBIT of $300. Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year. Assume that Lanley has a 100% payout rate, 1,500 shares outstanding, and that shareholders require a return of 5%. Assume that the tax rate is 0%.
Lanley Monorails is considering an open market stock repurchase. It plans to buy 20% of its outstanding shares at the price of $4.00 per share. The repurchased shares will be cancelled. It will finance the repurchase by issuing perpetual bonds worth a total sum of $1,200 and a coupon rate (and yield) of 3%. Assume that the tax rate is 0%.
If Lanley goes ahead with the repurchase, then what is the required return of stock holders after the repurchase is complete?
◦ 5.1%
◦ 5.3%
◦ 5.5%
◦ 5.7%
◦ 5.9%
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