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1. Ekobana Electronics has made the following forecast for the upcoming year based on the company’s current capitalization:
Interest expense $ 2,000,000.00
Operating income (EBIT) $20,000,000.00
Earnings per share $3.60
The company has RM20 million worth of debt outstanding and all of its debt yields 10 percent. The company’s tax rate is 40 percent. The company’s price earnings (P/E) ratio has traditionally been 12 times, so the company forecasts that under the current capitalization its stock price will be RM43.20 at year end.
The company’s investment bankers have suggested that the company recapitalize. Their suggestion is to issue enough new bonds at a yield of 10 percent to repurchase 1 million shares of common stock.
Assume that the stock can be repurchased at today’s $40 stock price. Assume that the repurchase will have no effect on the company’s operating income; however, the repurchase will increase the company’s dollar interest expense. Also, assume that as a result of the increased financial risk the company’s price earnings (P/E) ratio will be 11.5 times after the repurchase. Given these assumptions, what would be the expected year-end stock price if the company proceeded with the recapitalization?
show all the calculation process