Monroe Inc.is an all-equity firm with 500,000 shares outstanding.It has $2,000,000 of EBIT,and EBIT is expected to remain constant in the future.The company pays out all of its earnings,so earnings per share (EPS)equal dividends per share (DPS),and its tax rate is 25%.The company is considering issuing $3,000,000 of 9.00% bonds and using the proceeds to repurchase stock.The risk-free rate is 4.5%,the market risk premium is 5.0%,and the firm's beta is currently 1.05.However,the CFO believes the beta would rise to 1.25 if the recapitalization occurs.Assuming the shares could be repurchased at the price that existed prior to the recapitalization,what would the price per share be following the recapitalization? (Hint: P₀ = EPS/r_s because EPS = DPS. ) A) $34.47 B) $31.92 C) $33.20 D) $35.43 E) $26.81

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Quizplus · Accepted Answer

The cost of equity (r_s) after recapitalization can be calculated using the CAPM formula: r_s = risk-free rate + beta * market risk premium. With the new beta of 1.25, r_s = 4.5% + 1.25 * 5% = 10.75%. The EPS after recapitalization is calculated as (EBIT - interest) * (1 - tax rate) / new number of shares. The interest is $3,000,000 * 9% = $270,000. The new number of shares is 500,000 - ($3,000,000 / initial share price). The initial share price is calculated using the original EPS and cost of equity. Finally, the new share price is EPS after recapitalization divided by the new r_s.