Tapley Dental Supplies Inc. is in a stable, no growth situation. Its S1 000,000
ID: 2614690 • Letter: T
Question
Tapley Dental Supplies Inc. is in a stable, no growth situation. Its S1 000,000 of debt consists of perpetuities that have a 10% coupon and sell at par. Tapley's EBIT is s oo ooo its cost of equity is 15%. it has 100 000 shares outstanding, all earnings are paid out as dividends, and its federa plus state tax rate is 40% aple could borrow an additional $500,000 at an interest rate of 13% without having to retire the original debt, and it would use the proceeds to repurchase stock at the current price notat e new e u r un t e. e increased risk from the additional leverage will raise the cost of equity to 17%. If Tapley does recapitalize, what will be the new stock price? O a. $17.00 O b. $17.20 ? ?. $16.50 d. $16.00 ? e. $16.75Explanation / Answer
The Answer is “ b. $17.20 ”
Workings
Stock Price - Before capitalization
Value of the Firm = Net Operating Profit after tax / Cost of Equity
= [ $500,000 – ($10,00,000 x10% x 0.60) ] x0.60 / 0.15
= $240,000 / 0.15
= $16,00,000
Stock Price = Value of the firm / Number of shares outstanding
= $16,00,000 / 100,000 shares
= $16 per share
Stock Price – After capitalization
Value of the Firm = Net Operating Profit after tax / Cost of Equity
= [ { $500,000 – ($10,00,000 x10%) – ( 500,000 x 13% ) } x 0.60) ] x0.60 / 0.17
= $201,000 / 0.17
= $11,82,352.94
Stock Price = Value of the firm / Number of shares outstanding
= $11,82,352.94 / [ 100,000 shares– ( 500,000 / $16) ]
= $11,82,352.94 / [ 100,000 shares – 31,250 shares ]
= $11,82,352.94 / 68,750 shares
= $17.20 per share
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