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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)?

Solution Preview

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.

\$2.49