Question

Currently, Meyers Manufacturing Enterprises (MME) has a capital structure consisting of 35% debt and 65% equity. MME's debt currently has a 7% yield to maturity. The risk-free rate (rRF) is 5%, and the market risk premium (rM – rRF) is 6%. Using the CAPM, MME estimates that its cost of equity is currently 11.5%. The company has a 40% tax rate.

a. What is MME's current WACC? Do not round intermediate calculations. Round your answer to two decimal places. %

b. What is the current beta on MME's common stock? Do not round intermediate calculations. Round your answer to four decimal places.

c. What would MME's beta be if the company had no debt in its capital structure? (That is, what is MME's unlevered beta, bU?) Do not round intermediate calculations. Round your answer to four decimal places. MME's financial staff is considering changing its capital structure to 45% debt and 55% equity. If the company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to 7.5%. The proposed change will have no effect 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? Do not round intermediate calculations. Round your answer to two decimal places. %

e. What would be the company's new WACC if it adopted the proposed change in capital structure? Do not round intermediate calculations. Round your answer to two decimal places. %

f. Based on your answer to Part e, would you advise MME to adopt the proposed change in capital structure?

Answer 1

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12 e $ w v 1x : ENG 05-02 28-02-2020 22 EM750 1 750 751 X EJ fi E Formula Bar EL K EL EM EN kd = ke = 7.00% 11.50% 752 753 754 WACC = 755 756 We*ke + Wd*kd(1-t) (65%)*(11.5%)+(35%)*(7%)*(1-0.4) 8.95% WACC = 757 758 759 RISK PREMIUM risk free rate 6.00% 5.00% 760 761 762 763 764 765 766 767 Ke = Rf + beta (Rm-Rf) 11.50% = 5% + beta*(6%) 6.5% = beta(6%) beta = 1.0833 unlevered beta = levered beta /(1+ (D/E)(1-t)) unlevered beta = 1.0833/(1 + (35/65)(1-0.4)) unlevered beta = 0.8188 769 770 771 772 773 releveraging beta levered beta = unlevered beta*(1 + (D/E)(1-t)) levered beta = 0.8188*(1 + (45/55)(1-0.4)) levered beta = 1.2208 HPR GMAM EAC MACRS RELEVANTNPV BETA LEVERED ... Ml-np-ir REPLACEMENTS REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT LI ... ►

v ( ENG 05-02 28-02-2020 22 EM792 EI X EI fix EK EL EM EN EO EP EQ ER 1 769 770 771 772 releveraging beta levered beta = unlevered beta*(1 + (D/E)(1-t)) levered beta = 0.8188*(1 + (45/55)(1-0.4)) levered beta = 1.2208 773 775 776 beta 1.2208 RISK PREMIUM 6.00% risk free rate 5.00% COST OF EQUITY = ke = Rf + beta (Rm-Rf) ke = 5% + 1.2208*(6%)= 778 779 12.32% 780 kd = 7.50% 781 782 783 WACC = 784 785 786 We*ke + Wd*kd(1-t) (55%)*12.32%+(45%)*(7.5%)*(1-0.4) 8.80% WACC = 787 THE FIRM SHOULD PROCEED WITH REAPITALIZATION YES: As WACC has decreased 788 789 790 791 792 ... Mi-np-ir REPLACEMENTS HPR GMAM EAC MACRS RELEVANT NPV BETA LEVERED REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT LI... Đ i