Tapley Inc. currently has assets of $5 million, zero debt, is inthe 40% federal-

Question

Tapley Inc. currently has assets of $5 million, zero debt, is inthe 40% federal-plus-state tax bracket, has a net income of $1million, and pays out 40% of its earnings as dividends. Netincome is expected to grow at a constant rate of 5 percent peryear, 200,000 shares of stock are outstanding, and the current WACCis 13.40%.

The company is considering a recapitalization where it willissue $1 million in debt and use the proceeds to repurchasestock. Investment bankers have estimated that if the companygoes through with the recapitalization, its before-tax cost of debtwill be 11%, and its cost of equity will rise to 14.5%.

What is the stock's current price per share (before therecapitalization)?

Explanation / Answer

Net Income $1,000,000 Dividend Payment ($1,000,000 * 40%) $400,000 Number of Outstanding shares 200,000 Dividend Value per share ($400,000 / 200,000) $2 Dividend Paid (D0) $2 Dividend Growth Rate (g) 5% WACC 13.40% Stock's Current Price pershare    =   D1 / (R-g) Stock's Current Price pershare    = D0(1+g) / (R-g) Stock's Current Price pershare    = $2 (1.05) / (0.134 - 0.05) Current Share Value   = $2.10 /0.084 Current Share Value = $25 Net Income $1,000,000 Dividend Payment ($1,000,000 * 40%) $400,000 Number of Outstanding shares 200,000 Dividend Value per share ($400,000 / 200,000) $2 Dividend Paid (D0) $2 Dividend Growth Rate (g) 5% WACC 13.40% Stock's Current Price pershare    =   D1 / (R-g) Stock's Current Price pershare    = D0(1+g) / (R-g) Stock's Current Price pershare    = $2 (1.05) / (0.134 - 0.05) Current Share Value   = $2.10 /0.084 Current Share Value = $25

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