Merriweather Building has operating income of $20 million, a tax rate of 25%, and no debt. It pays out all of its net income as dividends and has a zero growth rate. The current stock price is $27 per share, and it has 5 million shares of stock outstanding. If it moves to a capital structure that has 40% debt and 60% equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10%. What would its stock price be if it changes to the new capital structure?

Question

Hudson Zimmerman

Business

10 June, 14:30

Merriweather Building has operating income of $20 million, a tax rate of 25%, and no debt. It pays out all of its net income as dividends and has a zero growth rate. The current stock price is $27 per share, and it has 5 million shares of stock outstanding. If it moves to a capital structure that has 40% debt and 60% equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10%. What would its stock price be if it changes to the new capital structure?

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Answers (2)

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Giovanny Grimes · Answer 1

Explanation:answered question too quickly

Colton Christensen · Answer 2

Value of firm = Operating income * (1-tax rate) / weighted average cost of capital = 20m * (1-0.25) / 0.10 = 150,000,000

Value of equity = Value of firm*60% = 150,000,000*60% = 90,000,000

Value of debt = Value of firm*40% = 150,000,000*40% = 60,000,000

New stock price per share =

[Value of equity + (Current debt-Previous debt) ]/number of shares =

= [90,000,000 + (48,000,000-0) ]/5,000,000 = 27.6