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

Question

Tapley Inc. currently has assets of $5 million, zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $1 million, and pays out 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5 percent 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%.

A. What is the stock's current price per share (before the recapitalization)?

B. Assuming the company maintains the same payout ratio, what will be its stock price following the recapitalization?

Explanation / Answer

Tapley Inc Outstanding Shares       200,000.00 Less: Shares bought back         40,000.00 1000000/(5000000/200000) Balance Shares       160,000.00 Net Income after Recapitalization Net Income     1,000,000.00 (after tax income) Less: After tax debt cost         66,000.00 Net Income after tax       934,000.00 Dividend payout ratio 40% Dividend Paid       373,600.00 Dividend per share                 2.34 373600/160000 Growth rate= 5% given Next Dividend per share =                 2.45 (+2.34+(2.34*5%)) Stock price after recap= Next Dividend/(Required return-Gwth rate) Stock price after recap= =2.45/(14.5%-5%) Stock price after recap=               25.79

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