Dabney Electronics Currently Has No Debt

Dabney Electronics currently has no debt. Its operating income is $20 million and its tax rate is 40 percent. It pays out all of its net income as dividends and has a zero growth rate. The current stock price is $40 per share, and it has 2.5 million shares of stock outstanding. If it moves to a capital structure that has 40 percent debt and 60 percent equity (based on market values) , its investment bankers believe its weighted average cost of capital would be 10 percent. What would its stock price be if it changes to the new capital structure?

A) $40
B) $48
C) $52
D) $54
E) $60

Correct Answer:

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