Answer: a.)$25 ; b.) $30.96
Explanation:
A.) Stock's current price per share:
Net income = $1,000,000
Dividend paid = 0.40 x $1,000,000 = $400,000
Dividend per share before recapitalization = $400,000 / 200,000 = $2
Price of the share before recapitalization is calculated as:
D1 = $2 × 1.05 = $2.10
P0 = D1/Ke - g
= $2.10/ 0.134 - 0.05
= $25
B.) Portion of equity after recapitalization = (200, 000 x $25) - $1,000,000 = $4,000,000
Portion of debt = $1,000,000
Revised WACC after recapitalization = Ke x E/V + Kd(1-t) x D/V
= 0.145 x $4,000,000/$5,000,000 + 0.11 x (1-0.40) x $1,000,000/$5,000,000
= 0.1292
= 12.92%
Revised net income is calculated as:
Before tax income = $1,000,000/0.60 = $5M
Interest = 0.11 x $1,000,000 = $110,000
Earning before tax = $1556666
40% of tax = $622,666.4
Net income = $933,999.60
Revised dividend = $933,999.60 x 0.40 = $373599.84
DPS = $373599.84/(200,000 - ($1,000,000/$25))
$373599.84/160,000
= $2.335
Revised price of the share after recapitalization:
$2.335 x 1.05 / 0.1292 - 0.05
2.45175 / 0.0792
= $30.96
