CONFIDENTIAL Question 2 Carnation Berhad is a manufacturer producing electrical appliances. Currently the company has no growth opportunities (g = 0), and it pays out all its earnings as dividends (EPS = DPS). Carnation's stock price can be calculated by simply dividing earnings per share by the required return on equity capital, which currently equals the WACC because the company has no debt. The company financial information are as follows: Total assets Operating income (EBIT) WACC Tax rate No of shares outstanding RM200 million RM40 million 10% 24% 3 million A new appointed CFO beliefs that the company would be much better off if it were to change its capital structure to 40% debt and 60% equity. After meeting with investment bankers, the CFO concludes that the company could issue RM25 million of debt at a before-tax cost of 5%. The RM25 million raised from the debt issue would be used to repurchase stock at the current price. The repurchase will have no effect on the firm's EBIT; however, after the repurchase, the cost of equity will increase to 12%. Required: a) Calculate the stock price before the recapitalization. (4 Marks) b) What will be its estimated stock price after the capital structure change if Carnation Berhad follows the CFO's advice? (4 Marks) c) Should Carnation Berhad follows the CFO advice? (2 Marks) (Total: 10 Marks)