Tartan Industries currently has total capital equal to $4 million, haszero debt, is in the 40% federal-plus-state tax bracket, has a net income of $1 million, anddistributes 40% of its earnings as dividends. Net income is expected to grow at a constantrate of 3% per year, 200,000 shares of stock are outstanding, and the current WACC is12.30%.The company is considering a recapitalization where it will issue $2 million in debtand use the proceeds to repurchase stock. Investment bankers have estimated that if thecompany goes through with the recapitalization, its before-tax cost of debt will be 10% andits cost of equity will rise to 15.5%.a. What is the stock’s current price per share (before the recapitalization)?b. Assuming that the company maintains the same payout ratio, what will be its stockprice following the recapitalization? Assume that shares are repurchased at the pricecalculated in part a.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Tartan Industries currently has total capital equal to $4 million, has
zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $1 million, and
distributes 40% of its earnings as dividends. Net income is expected to grow at a constant
rate of 3% per year, 200,000 shares of stock are outstanding, and the current WACC is
12.30%.
The company is considering a recapitalization where it will issue $2 million in debt
and use the proceeds to repurchase stock. Investment bankers have estimated that if the
company goes through with the recapitalization, its before-tax cost of debt will be 10% and
its cost of equity will rise to 15.5%.
a. What is the stock’s current price per share (before the recapitalization)?
b. Assuming that the company maintains the same payout ratio, what will be its stock
price following the recapitalization? Assume that shares are repurchased at the price
calculated in part a.

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