Chapter 14, Problem 9P

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# RECAPITALIZATION Tartan industries currently has total capital equal to $4 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 glow at a constant rate of 3% per year, 200,000 shares of stock are outstanding, and the current WACC is 12.30%.The company is considering a recapitalization where it will issue $2 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, it’s before-tax cost of debt will be 10% and its cost of equity will rise to 15.5%. a. What is the stock’s current price per share (before the recapitalization)? b. 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 determine: The stock’s present price per share before the recapitalization. Introduction: Recapitalization: The recapitalization refers to the process of changing the structure of the capital as per the requirements of a company. Explanation Given information: The total capital is$4 million.

The tax rate is 40%.

The net income is $1 million. The payout ratio is 40%. The net income grows at 3%. The number of shares outstanding is 200,000. The WACC is 12.30%. Calculation of the stock’s current price per share: The formula to calculate the stock’s current price per share is: Stockpricepershare=Dividendpaidpershare×(1+Growthrate)(WACCGrowthrate) Substitute$2 for the dividend paid per share (working note), 3% for growth rate, 12.30% for WACC and 3% for growth rate in the above formula,

Stockpricepershare=\$2×(1+3%)(12

b.

Summary Introduction

To determine: The stock’s current price per share after the recapitalization.

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