Prokter and Gramble? (PKGR) has historically maintained a? debt-equity ratio of approximately 0.17. Its current stock price is $45 per? share, with 2.9 billion shares outstanding. The firm enjoys very stable demand for its? products, and consequently it has a low equity beta of 0.425 and can borrow at 4.5?%, just 20 basis points over the? risk-free rate of 4.3%. The expected return of the market is 9.7?%, and? PKGR's tax rate is 32?%.
a. This? year, PKGR is expected to have free cash flows of ?$5.7 billion. What constant expected growth rate of free cash flow is consistent with its current stock? price?
b. PKGR believes it can increase debt without any serious risk of distress or other costs. With a higher? debt-equity ratio of 0.425?, it believes its borrowing costs will rise only slightly to 4.8?%.
If PKGR announces that it will raise its? debt-equity ratio to 0.425 through a leveraged? recap, determine the increase or decrease in the stock price that would result from the anticipated tax savings.