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 distributes 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5% 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%.

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

Answer 1

The stock's current price per share is $37.50 a share

Step-by-step explanation:

According to the given data, 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.

Therefore, 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.

The stock's current price per share is $37.50 a share