Recapitalization 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 pays out 40% of its earning 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 equality will rise to 14.5%.
a. What is the stock’s price per share as of right now?
b. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchases at the price calculated in Part
Explain how you got your answer
Evaluating risk and return stock X has a 10% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%.
a. Calculate each stock’s coefficient of variation.
b. Which stock is riskier for a diversified investor?
c. Calculate each stock’s required rate of return.
d. On the basis of the two stocks’ expected and required returns, which stock would be more attractive to a diversified investor?
e. Calculate the required return of a portfolio that has $7,500 invested in Stock X and $2,500 invested in Stock Y.
f. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return