BEA is considering a change in its capital structure BEA cur

BEA is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%,and its stock price is $40per share with 2 million shares outstanding. BEA is a zero-growth firm and pays out all its earnings as dividends. The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-state tax rate.The market risk premium is 4% and the risk-freerate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing 3shares with the extra money that is borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.00

i.What is BEA’s current WACC?

ii.What is BEA’s unlevered beta?

iii.What’s BEA’s new beta and cost of equity?

iv.What’s BEA’S new WACC?

v.What’s BEA’s total value of the firm with 40% debt?vi.What’s BEA’S value of equity and debt, when debt is 40% of the capital structure?vii.What’s the value of a share before the repurchase?

viii.After retiring the old debt, how much cash is left to repurchase shares?

ix.How many shares will be outstanding after the repurchase?x.What will the priceof a share be after the repurchase?

Solution

Cost of Equity (re) = rf+ BX(rf-rm) = 6%+1X(4%) = 10% Cost of Debt (rd) = 8% Tax rate (t) = 40% Value of total equity = 40X2 million $ 80 million $ Proportion of Debt (D/V) = 20/(20+80) = 0.2 Proportion of equity (E/V) = 80/(20+80) = 0.8 WACC = reX(E/V)+rdX(1-t)X(D/V) = 10%X0.8+8%X0.2X(1-40%) WACC = 8.96% Levered Beta (Bl) = Unlevered Beta (Bu)X(1+(1-t)XD/E) 1 = BuX(1+(1-40%)X(20/80) Bu = 0.87