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    Stock price following the recapitalization

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    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%.

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

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    Solution Preview

    Step 1: Calculate EBIT before the recapitalization:
    EBIT = $1,000,000/(1 - T) = $1,000,000/0.6 = $1,666,667.

    Step 2: Calculate net income after the recapitalization:
    Debt is 1,000,000 and the ...

    Solution Summary

    The solution explains how to calculate the stock price following the recapitalization