Capital Structure, Volume 3, page 128, Q#17

CFA Level II Corporate Finance
#1

Hello,

I am trying to understand how the sentence “… in order to buy back an equivalent amount of equity” is accounted to derive the the solution. I couldn’t understand the meaning of it.

Does the solution make any difference if the above statement is not there?

Thanks in advance.

#2

… Yes the answer will be different. The debt/equity will be different.

“… in order to buy back an equivalent amount of equity” means Garth will issue debt worth of 1 mill and use it to buy back stock worth 1 mill. thus Debt increase and equity decreaces. In the question you are given the cost of capital of Garth with 100% equity finance (0 debt) which means this cost of capital is the same as cost of equity.