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Consider an all-equity firm with 125,000 shares outstanding. Assume that EBIT=800,000 and that EBIT will remain...

Consider an all-equity firm with 125,000 shares outstanding. Assume that EBIT=800,000 and that EBIT will remain constant, the firm pays out all profits (EPS = dividends per share) as dividends, and that its tax rate is 40%. If the firm’s beta is 1.1, the risk-free rate is 4%, and the market risk premium is 6%, what is the firm’s stock price according to the dividend growth model?

Now assume the firm is considering issuing $1.2m in debt at before-tax cost of 7%, using the proceeds to repurchase stock at the share price from #1. If this capital structure adjustment results in a debt-to-equity ratio of .25 for the firm, what will the stock’s price be after recapitalization?
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