ABC is an unlevered firm and is currently valued at $10 million. It has 1 million shares outstanding.

As part of a management buyout (MBO), ABC is planning to borrow $6 million from a bank at an annual interest rate of 4.25%. ABC would repurchase $6 million worth of stock with the proceeds of the bank loan. The bank agreement stipulates that the debt should be amortized in 5 equal annual payments, which include the principal payment plus the 4.25% interest. The payments are at the end of each year.

Due to an expected increase in competition, the firm will revert to its original capital structure (0% debt) after year 5. The current cost of equity is 10% and the corporate tax rate is 35%. Managers currently own 25% of the outstanding shares and they will not participate in the repurchase program.

a) By how much the price per share of Company ABC would change at the time of the announcement of the MBO?

b) What proportion of the outstanding shares would managers own after the MBO?