1. A company currently has assets of $5 million and it is 100 percent equity financed. The company currently has net income of $1 million and it pays out 40 percent of its net income as dividends. Both net income and dividends are expected to grow at a constant rate of 5 percent per year. There are 200,000 shares of stock outstanding, and it is estimated that the current cost of capital is 13.4 percent. The company is considering a recapitalization exercise where it will issue $1 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes ahead with the recapitalization, its before-tax cost of debt will be 11 percent, and the cost of equity will rise to 14.5 percent. The company has a 40 percent tax rate.

1. What is the current share price of the stock (i.e. before recapitalization)

2. Assume that the company maintains the same payout ratio, what will be the stock price after recapitalization.
3. A company currently has assets of $5 million and it is 100 percent equity financed. The company currently has net income of $1 million and it pays out 40 percent of its net income as dividends. Both net income and dividends are expected to grow at a constant rate of 5 percent per year. There are 200,000 shares of stock outstanding, and it is estimated that the current cost of capital is 13.4 percent. The company is considering a recapitalization exercise where it will issue $1 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes ahead with the recapitalization, its before-tax cost of debt will be 11 percent, and the cost of equity will rise to 14.5 percent. The company has a 40 percent tax rate.
4. What is the current share price of the stock (i.e. before recapitalization)
5. Assume that the company maintains the same payout ratio, what will be the stock price after recapitalization.