Question
Based on the current capitalization, KHM Sdn Bhd has made the following forecast for the coming year: Interest expense RM2,000,000 Operating income (EBIT) RM40,000,000 Earnings
Based on the current capitalization, KHM Sdn Bhd has made the following forecast for the coming year: Interest expense RM2,000,000 Operating income (EBIT) RM40,000,000 Earnings per share RM4.00 The company has RM20,000,000 worth of debt outstanding and all of its debt yields 10 %. The companys tax rate is 30%. The companys price earnings (P/E) ratio has traditionally been 10. The companys investment bankers have suggested that the company recapitalize. Their suggestion is to issue enough new bonds at a yield of 10% to repurchase 1,400,000 shares of common stock. Assume that the repurchase will have no effect on the companys operating income; however, the repurchase will increase the companys dollar interest expense. Also, assume that as a result of the increased financial risk, the companys price earnings (P/E) ratio will be 10.5x after the repurchase. What would be the expected year-end stock price if the company proceeded with the recapitalization? Should KHM proceed with the recapitalization?
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