Dabney Electronics Currently Has No Debt

question 14

Multiple Choice

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

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Definitions:

Corporation

A legal entity that is separate from its owners, providing them with limited liability, and able to own assets, borrow money, and be sued.

Professional Corporation

A business structure that allows licensed professionals to offer their services while enjoying certain legal and tax advantages.

Liable

Having legal responsibility or obligation, often used in the context of owing money or being responsible for specific actions or outcomes.

Malpractice

Professional misconduct or failure to exercise adequate skill, leading to loss or injury to a patient or client.