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

[rockmania]

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.

 

[Zanalyst]

…. 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.