RECAPITALIZATION: Tapley Inc. currently has total capital equal to $8 million, h

Question

RECAPITALIZATION: Tapley Inc. currently has total capital equal to $8 million, has zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $2 million, and pays out 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5% per year, 340,000 shares of stock are outstanding, and the current WACC is 12.70%. The company is considering a recapitalization where it will issue $5 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 15.5%. A.) What is the stock's current price per share (before the recapitalization)? Round your answer to the nearest cent. $ ____________ 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. Round your answer to the nearest cent. Do not round intermediate steps. $ ________

Explanation / Answer

Outstanding Shares after recapitalization 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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