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Question
Van Slyke Inc. has $5,000,000 in assets, and currently has no debtu23afit is financed entirely with 200,000 shares of common stock, each of which trades at $25 per share. The firm's EBIT is expected to be $1,250,000 at year end (i.e., at t = 1). The corporate tax rate is 40 percent. Van Slyke expects to pay out a dividend at year end which is 50 percent of its net income. The company estimates that its earnings and dividends grow at a constant rate of 3 percent a year. The company is considering a recapitalization where they would issue $1,000,000 of debt at a before-tax cost of 10 percent. The proceeds from the debt issued would be used to repurchase shares of the company's stock at $25 per share. The company's investment bankers estimate that the cost of equity capital would be 16 percent after the recapitalization. What would you expect the company's stock price to be immediately following the recapitalization? Assume that the dividend has not yet been paid.
a. $12.15
b. $16.59
c. $20.98
d. $27.25
e. $33.17
Answer
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