Problem:
A consultant has collected the following information regarding Gannette Publishing:
Total Assets: 6,000 million
Operating income (EBIT): 400 million
Interest Expense: 0 million
Net income: 280 million
Share Price: 32
Tax Rate: 40 percent
Debt Ratio: 0 percent
Market/Book ratio: 1.00x
EPS = DPS $3.20
The company has no growth opportunities ( g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). Gannette's stock price can be calculated by simply dividing earnings per share by the required return on equity capital, which currently equals the WACC because the company has no debt.
The consultant believes that the company would be much better off if it were to change its capital structure to 40 percent debt and 60 percent equity. After meeting with investment bankers, the consultant concludes that the company could issue $1,200 million of debt at a before-tax cost of 7 percent, leaving the company with interest expense of $84 million. The $1,200 million raised from the debt issue would be used to repurchase stock at $32 per share. The repurchase will have no effect on the firm's EBIT; however, after the repurchase, the cost of equity will increase to 11 percent. If the firm follows the consultant's advice, what will be its estimated stock price after the capital structure change? You will receive 10 points each for calculating the current number of shares outstanding currently, the number of shares outstanding after repurchase, the new EPS after repurchase, and the new stock price.
You must show all calculations for full credit.