Question

An all-equity firm with 200,000 shares outstanding, Antwerther Inc., has $2,000,000 of EBIT, which is expected to remain constant in the future. The company pays out all of its earnings, so earnings per share (EPS) equal dividends per shares (DPS). Its tax rate is 40%. The company is considering issuing $5,000,000 of 10.0% bonds and using the proceeds to repurchase stock. The risk-free rate is 6.5%, the market risk premium is 5.0%, and the beta is currently 0.95, but the CFO believes beta would rise to 1.10 if the recapitalization occurs. Assuming that the shares can be repurchased at the price that existed prior to the recapitalization, what would the price be following the recapitalization? $65.77 $69.23 $70.59 $71.33 $74.14

can you explain how to get the after the recapitalization DPS, i understand that is (EBIT-(rd*bonds)(1-t)/shares) , can yo tell what is bonds and shares, respectively numbers values

Answer 1

Answer : Price of the Stock is $70.59

a) Calculation of Number Of Shares to be Bought Back

Required Return = Rf + (Rm-Rf)β

                                = 6.5% + (5%)0.95

                                = 11.25 %

Sr	Particulars	Amount $
a	EBIT	2000000
b	Less: Interest	0
c	EBT	2000000
d	Less: TAX @ 40%	800000
e	EAT	1200000
f	No of Shares	200000
g	Earnings Per Share or Dividend Per Share	6
h	Required Return (Re)	11.25%
i	Value of Share (Dividend/Re)	53.33
j	Amount available for Purchase	5000000
k	Number of Shares to be bought back (j/i)	93750

  

b) Calculation of Post Capitalization Share Price

Post Capitalization Required Return = Rf + (Rm-Rf)β

= 6.5% + (5%)1.1

= 12 %

Sr	Particulars	Amount $
a	EBIT	2000000
b	Less: Interest ( 5000000* 10%)	500000
c	EBT	1500000
d	Less: TAX @ 40%	600000
e	EAT	900000
f	No of Shares ( 200000-93750)	106250
g	Earnings Per Share or Dividend Per Share	8.47
h	Required Return (Re)	12.00%
i	Value of Share (Dividend/Re)	70.59