5. Recapitalization Todd Industries currently has about $4,000,000 of debt in it
ID: 2653469 • Letter: 5
Question
5. Recapitalization Todd Industries currently has about $4,000,000 of debt in its capital structure, on which it pays 10% interest. However, Todd is considering issuing new long-term debt and repurchasing some of its 600,000 outstanding shares. Todd's EBIT will not change and it is expected to stay constant at $3,600,000 throughout the foreseeable future. Todd also pays out all its earnings as dividends (that is, EPS = DPS). Todd's beta is currently 1.10, and the risk-free rate and market risk premium are both 6.0%. If the firm's tax rate is 40%, what is Todd's current stock price? $29.76 $25.40 $38.10 $27.78 $33.33 Todd's CFO is suggesting that the firm issue $2,000,000 more debt and use the proceeds to repurchase some of its common stock. Assume the firm can repurchase shares at its current stock price. How many shares can Todd repurchase? 78,750 shares 80,000 shares 57,600 shares 72,000 shares 52,500 shares Todd's CFO estimates that the firm's beta after the recapitalization would be 1.15. After the new debt is issued, the firm will be paying an average cost of h% on its $6,000,000 of outstanding debt. What is Todd's expected stock price after the recapitalization? $33.94 $26.23 $29.31 $35.29 $32.39Explanation / Answer
5 a)
EBIT = 3600000
Interest Expenses = 4000000*10% = 400000
Earning before Tax = 3200000
Tax expenses = 40%*3200000 = 1280000
Earning after Tax = 1920000
No of outstanding Share = 600000
EPS = 1920000/600000
EPS = $ 3.20
As mention in question 100% payout
therefore DPS = $ 3.2
As per CAPM
Cost of Equity = Rf + market risk premium*beta
Cost of Equity = 6 + 6*1.1
Cost of Equity = 12.6%
Stock Price = DPS/Cost of Equity
Stock Price = 3.2/12.6%
Stock Price = $ 25.40
Answer
b) $ 25.40
b)
No of Share Todd can Purchase = 2000000/25.39683
No of Share Todd can Purchase = 78750 Shares
Answer
A) 78750 Shares
c)
EBIT = 3600000
Interest Expenses = 6000000*11% = 660000
Earning before Tax = 2940000
Tax expenses = 40%*2940000 = 1176000
Earning after Tax = 1764000
No of outstanding Share = (600000-78750) = 521250
EPS = 1764000/521250
EPS = $ 3.3842
As mention in question 100% payout
therefore DPS = $ 3.3842
As per CAPM
Cost of Equity = Rf + market risk premium*beta
Cost of Equity = 6 + 6*1.15
Cost of Equity = 12.9%
Stock Price = DPS/Cost of Equity
Stock Price = 3.3842/12.9%
Stock Price = $ 26.23
Answer
b) $ 26.23
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