Question
ABC has historically maintained a debt-equity ratio of approximately 0.15. Its current stock price is $30 per share, with 2 million shares outstanding. The firm
ABC has historically maintained a debt-equity ratio of approximately 0.15. Its current stock price is $30 per share, with 2 million shares outstanding. The firm enjoys very stable demand for its products, and consequently it has a low equity beta of 0.3 and can borrow at 5%, when the risk-free rate is 4.25%. The expected return of the market is 10%, and ABCs tax rate is 35%. a. This year, ABC is expected to have unlevered free cash flows of $3 million. What constant expected growth rate of free cash flow is consistent with its current stock price? b. ABC believes it can increase debt without any serious risk of distress or other costs. With a higher debt-equity ratio of 0.3, it believes its borrowing costs will rise only slightly to 5.5%. If ABC announces that it will raise its debt-equity ratio to 0.3 through a leveraged recap, determine the increase in the stock price that would result from the anticipated tax savings.
ABC has historically maintained a debt-equity ratio of approximately 0.15. Its current stock price is $30 per share, with 2 million shares outstanding. The firm enjoys very stable demand for its products, and consequently it has a low equity beta of 0.3 and can borrow at 5%, when the risk-free rate is 4.25%. The expected return of the market is 10%, and ABC 's tax rate is 35% a. This year, ABC is expected to have unlevered free cash flows of $3 million. What constant expected growth rate of free cash flow is consistent with its current stock price? b. ABC believes it can increase debt without any serious risk of distress or other costs. With a higher debt-equity ratio of 0.3, it believes its borrowing costs will rise only slightly to 5.5%. If ABC announces that it will raise its debt-equity ratio to 0.3 through a leveraged recap, determine the increase in the stock price that would result from the anticipated tax savingsStep by Step Solution
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