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Prokter and Gramble(PKGR) has historically maintained adebt-equity ratio of approximately 0.19. Its current stock price is $54 pershare, with 2.8 billion shares outstanding. The firm

Prokter and Gramble(PKGR) has historically maintained adebt-equity ratio of approximately 0.19. Its current stock price is $54 pershare, with 2.8 billion shares outstanding. The firm enjoys very stable demand for itsproducts, and consequently it has a low equity beta of 0.475 and can borrow at 3.8%, just 20 basis points over therisk-free rate of 3.6%. The expected return of the market is 10.1%, andPKGR's tax rate is 25%.

a. Thisyear, PKGR is expected to have free cash flows of $6.7 billion. What constant expected growth rate of free cash flow is consistent with its current stockprice?

b. PKGR believes it can increase debt without any serious risk of distress or other costs. With a higherdebt-equity ratio of 0.475, it believes its borrowing costs will rise only slightly to 4.1%. If PKGR announces that it will raise itsdebt-equity ratio to 0.475 through a leveragedrecap, determine the increase or decrease in the stock price that would result from the anticipated tax savings.

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