Tapley Inc. currently has total capital equal to $5 million, has zero debt is in

Question

Tapley Inc. currently has total capital equal to $5 million, has 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% per year, 200000 shares of stock are outstanding and the current WACC is 13.40%

The company is considering a recapitalization where it will issue $1 million un 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%.

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

Explanation / Answer

Since company has no debt the current WACC = Required return on equity. We can use the dividend discount model to find the price of the shares. Current value of firm = Dividend*(1+growth rate)/(required return-growth rate) Current value = 1,000,000*40%*(1.05)/(0.1340-0.05) = $7,500,000 Price per share = value/shares outstanding Price per share = $7,500,000/200,000 = $37.50 a share.

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