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Fundamentals of Financial Manageme...

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

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BuyFindarrow_forward

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%.

  1. a. What is the stock’s current price per share (before the recapitalization)?
  2. 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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