MiniSink is a manufacturing company that has $100 million in debt outstanding and 9 million shares trading at $100 per share. The current beta is 1.10, and the interest rate on the debt is 8 percent. In the latest year, MiniSink reported a net income of $7.50 per share, and analysts expect earnings growth to be 10 percent a year for the next five years. The firm faces a tax rate of 40 percent and pays out 20 percent of its earnings as dividends (the Treasury bond rate is 7 percent).
a. Estimate the debt ratio each year for the next five years, assuming that the firm maintains it current payout ratio.
b. Estimate the debt ratio each year for the next five years, assuming that the firm doubles its dividends and repurchases 5 percent of the outstanding stock every year.