Ch 13 class problem

Ch 13 class problem - ($2,000,000(1 0.4/200,000 = $6.00...

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Ch 13 problem ABC is all equity, with 200,000 shares outstanding. EBIT is $2,000,000 and will remain constant. All earnings are paid out as dividends. The tax rate is 40%. The firm wants to issue $2 million in bonds and repurchase stock. The bonds would have a YTM of 10%. The risk free rate is 6.6% and the market risk premium is 6%. Beta is 0.9, but would rise to 1.1 if the recap happens. What would be the stock price after recapitalization? First, find the company's current cost of capital, dividends per share, and stock price: k s = 0.066 + (0.06)0.9 = 12%. To find the stock price, you still need the dividends per share or DPS =
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Unformatted text preview: ($2,000,000(1 - 0.4))/200,000 = $6.00. Thus, the stock price is P = $6.00/0.12 = $50.00. Thus, by issuing $2,000,000 in new debt the company can repurchase $2,000,000/$50.00 = 40,000 shares. Now after recapitalization, the new cost of capital, DPS, and stock price can be found: k s = 0.066 + (0.06)1.1 = 13.20%. DPS for the remaining (200,000 - 40,000) = 160,000 shares are thus [($2,000,000 - ($2,000,000 × 0.10))(1 - 0.4)]/ 160,000 = $6.75. And, finally, P = $6.75/0.132 = $51.14....
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