Gil Co., currently has a debt-equity ratio of approximately 0.20. Its current stock price is $50 per share, with 2.5 billion shares outstanding. The firm has an equity beta of 0.50 and can borrow at 4.20%. The risk-free rate is 4%. The expected return of the market is 10%, and the firm’s tax rate is 35%.
a. This year, the firm expects free cash flows of $6.0 billion. What constant expected growth rate of free cash flow is consistent with its current stock price?
b. The firm believes it can increase debt to 0.50 with no other significant costs. At this level, bondholders will demand an interest rate of 4.50%. If the firm announces that they will raise the debt-equity ratio to 0.5 through a leveraged recap, determine the increase in the stock price that would result from the anticipated tax savings.