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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

RECAPITALIZATION Tapley Inc. currently has total capital equal to $5 million, has zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $1 million, and distributes 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5% per year, 200,000 shares of stock are outstanding, and the current WACC is 13 40%. The company is considering a recapitalization where it will issue $1 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, its before-tax cost of debt will be 11% and its cost of equity will rise to 14 5%.

  1. a. What is the stock’s current price per share (before the recapitalization)?
  2. b. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchased at the price calculated in part a.

a.

Summary Introduction

To identify: The current price of the stock.

Recapitalization:

Recapitalization is the process to change the capital structure such as equity and debt of the company as per the requirement.

Explanation

Compute the dividend per share.

Given,

The net income is 1 million.

The payout ratio is 40%.

The outstanding shares are 20,000.

Formula to calculate the dividend per share,

Dividendpershare=Netincome×PayoutratioOutstandingshares

Substitute $1,000,000 for net income, 0.40 for payout ratio and 200,000 for outstanding shares.

Dividendpershare=$1,000,000×0.40200,000=400,000200,000=$2

The dividend per share is $2.

Compute the current price of stock.

The growth rate is 5% or 0.05. (Given)

The cost of equity is 13.40%. (Given)

The dividend per share is $2

b.

Summary Introduction

To identify: The stock price per share to follow the updated capital structure.

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