Question $2$

Based on the current capitalization, Roce Sdn Bhd $($RSB$)$ has made the following forecast for the

coming year:

Interest expense RM$1,200,000$

Operating income $($EBIT$)$ RM$20,000,000$

Earnings per share RM$2\mathrm{.}50$

The company has RM$20,000,000$ worth of debt outstanding and all of its debt yields $6\%.$ The

company$$s tax rate is $30\%.$ The company$$s price earnings $($P$/$E$)$ ratio has traditionally been $8$x$.$

The company$$s investment bankers have suggested that the company recapitalize. Their

suggestion is to have an additional amount of debt by issuing enough new bonds at a yield of $6\%$

to repurchase $1,400,000$ shares of common stock.

Assume that the repurchase will have no effect on the company$$s operating income; however, the

repurchase will increase the company$$s dollar interest expense. Also, assume that as a result of

the increased financial risk, the company$$s price earnings $($P$/$E$)$ ratio will be $8$x after the

repurchase.

What would be the expected year$-$end stock price if the company proceeded with the

recapitalization? Should RSB proceed with the recapitalization? $(10$ Marks$)$