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Fundamentals of Financial Management See all exercises

Chapter 14, End of Chapter, Problems, Exercise 14-11

Part a Part b Part c Part d Part e Part f

RECAPITALIZATION
 
a. What is Forever's current WACC? 
b. What is the current beta on Forever's common stock? 
c. What would Forever's beta be if the company had no debt in its capital structure?
        (That is, what is Forever's unlevered beta, bU?) 
Forever's nancial sta is considering changing its capital structure to 40% debt and 60% equity. If the
company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to
10.5%. The proposed change will have no e ect on the company's tax rate. 
d. What would be the company's new cost of equity if it adopted the proposed change in capital structure? 
e. What would be the company's new WACC if it adopted the proposed change in capital structure?
f. Based on your answer to part e, would you advise Forever to adopt the proposed change in capital structure?
Explain.

Here is the step-by-step explanation, veri ed by an educator:

Step 1 of 2

Identify the current capital structure (debt and equity), risk-free rate (rF), market risk premium (RPM), cost of debt (rD), tax rate (T)
and cost of equity (rS)

D = 0.40
E = 0.60
rF = 6%
RPM = 7%
rD = 10.50%
T = 40%
rS = 15.92%

Step 2 of 2

Calculate the WACC using the variables identi ed in step 1

W ACC = (rD )(D)(1 − T ) + (E)(rS )

                = (0.1050)(0.40)(1 − 0.40) + (0.60)(0.1592)
                = 12.07 %

Final answer 숥

12.07%

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쇲 P, Ex 14-10 P, Ex 14-12 쇰

Textbook Solutions / Fundamentals of Financial Management / Ch 14, End of Chapter, Ex 14-11

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