Question

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?

Answer 1

Answer:

Explanation:

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

Answer 2

Answer:

Explanation:answered question too quickly