Question

Tartan Industries currently has total capital equal to $9 million, has zero debt, is in the 25% federal-plus-state tax bracket, has a net income of $3 million, and distributes 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5% per year, 480,000 shares of stock are outstanding, and the current WACC is 13.40%. The company is considering a recapitalization where it will issue $2 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 15.5%. a. What is the stock's current price per share (before the recapitalization)? Do not round intermediate calculations. Round your answer to the nearest cent. b. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchased at the price calculated in part a. Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

В ДА 1 2 a. Before Capitalalization WACC (all equity) Constant growth rate 13.40% 5% Net Income outstanding stock Earning per share Dividend payout ratio Dividend per share $3,000,000.00 480,000 $6.25 40% $2.50 10 11 13 Current Price of stock $31.25 15 16 b. 17 Cost of Equity Pre tax cost of debt Tax rate 15.50% 11% 25% 18 19 20 Debt issued No. stock repurchased Remaining outstanding stock $2,000,000.00 64,000 416,000 EBIT Interest EBT $4,000,000.00 $220,000.00 $3,780,000.00 $945,000.00 $2,835,000.00 Tax Net Income EPS $6.81 $2.73 DPS Stock Price $27.26

Cell reference -

ДА 2 a. Before Capitalalization WACC (all equity) Constant growth rate 0.134 0.05 Net Income outstanding stock Earning per share Dividend payout ratio Dividend per share 3000000 480000 =C7/08 0.4 =C9*c10 12 13 Current Price of stock =(C11*(1+C5))/(C4-C5) 14 15 16 17 b. Cost of Equity Pre tax cost of debt Tax rate 0.155 0.11 0.25 Debt issued No. stock repurchased Remaining outstanding stock 2000000 =C20/C13 =C8-C21 EBIT Interest EBT Tax Net Income =C7/(1-C18) 1=C20*C17 =C24-C25 =C26*C18 =C26-C27 EPS DPS =C28/C22 =C30*C10 Stock Price (C31*(1+C5))/(C16-C5)

Please note:

Assumption-constant growth rate remain same after recapitalization.

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.