Question Details

cost of capital




1. (Point values are as listed) Use the following information for the next several questions. Consider a world of perfect
capital markets. This world has no corporate or personal taxes, all investors have homogeneous expectations, no
bankruptcy costs, and M&M- no-tax theory of capital structure is true.
Company Y is financed has the following market value balance sheet:
Assets = $355 Liabilities = $81
Equity = $274
The firm had $31.95 in EBIT last year. The firm has 50 shares outstanding. The firm expects this same return for the
foreseeable future. The firm is a zero growth firm, that pays out all excess earnings as dividends. Any time the firm
changes its capital structure, it changes only the debt/equity mix and does not change its total assets. The firm-
liabilities consists entirely of perpetual debt. The firm- debt is risk-less, perpetual, selling at par, and has a 4% yield. If
the firm were to change its capital structure, new debt would still have a 4% yield. The expected return on the market is
9%. Given this information, answer the following questions:
a. (3 points) What is the firm- return on equity?

b. (3 points) What is the firm- current weighted average cost of capital.

c. (3 points) What is the current price per share?

d. (3 points) What is the beta of the firm- levered equity?

Now assume that the above firm issues enough equity to repurchase all of the firm- debt. This change in capital
structure reveals no new information about future firm prospects.
e. (3 points) What is the overall firm- new return on equity?

f. (3 points) What is the firm- new unlevered equity beta?







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