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    Stock prices with recapitalization

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    Crumpley Co. has $5 M is current assets, zero debt, in 40% tax bracket, net income of $1 M. NI is expected to grow at a constant rate of 5%/year. 200,000 shares outstanding and current WACC of 13.40%. The company is considering a recapitalizaiton where it will issue $1M in debt and use proceeds to repurchase stock. Before-tax cost of debt is 11%, equity will rise to 14.5%. What is the stock's current price/share before recapitalization and following recap (co. maintains same payout ratio)?

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    Solution Preview

    Please see the attached file.

    Net Income= $1,000,000
    Tax rate = 40%
    EBIT (1-Tax rate) = Net Income
    or EBIT = Net Income / (1-Tax rate)= $1,666,667
    growth rate= 5%
    Therefore EBIT net year= 1.05 x $1,666,667= $1,750,000

    Before recapitalization:

    EBIT next year= $1,750,000
    Interest= $0
    Earnings before ...

    Solution Summary

    The solution calculates share price before and after recapitalization.