Question

Optimal Capital Structure with Hamada Beckman Engineering and Associates (BEA) Is considering a change in its capital structure. BEA currenty has $20 million in d bt carrying a rate of 7%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. The firm's EBIT is s 12.615 million, and it faces a 40% federal plus state tax rate. The market risk premium is 6%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 45% debt, based on market values, and r 0.8 shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 10%. BEA has a beta of a. What is BEA's unlevered beta? Use market value Dfs (which is the same as s) when unlevering. Do not round intermediate calculations. Round your answer to two decimal places. b. what are BEA's new beta and cost of equity if it has 45% debt? Do not round intermediate calculations. Round your answers to two decimal places. Beta Cost of equity: c. what are BEA's WACC and total valu of the firm with 45% debt? Do not round intermediate calculations. Round your answer to two decimal places. what is the total value of the rm with 45% debt? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55 Do not round intermediate calculations. Round your answer to three decimal places. million

Answer 1

a) Levered Beta =0.8

Levered beta= Unlevered beta* (1+(1-t) D/E)

D=Debt= $20 mn

Equity=40*2 =$80mn

t=tax rate =40%

Unlevered beta= 0.8/(1+(1-.4)*20/80) = 0.70 or 0.69

b)Levered beta= Unlevered beta* (1+(1-t) D/E)

=0.7*(1+(1-.4)*45/55) =1.04

cost of equity= risk free rate+beta*market risk premium = 6% +1.04*6% =12.24%

c) WACC= Debt*cost of debt*(1-t) +Equity*cost of equity

=45%*10*(1-0.4) +55%*12.24 =9.43%

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