Question
16-1: United Producers (UP) , an unleveraged firm, has a total market value of $15 million, consisting of 600,000 shares of common stock selling at
16-1: United Producers (UP), an unleveraged firm, has a total market value of $15 million, consisting of 600,000 shares of common stock selling at $25 per share.Management is considering recapitalizing by issuing enough debt so that the firm has a capital structure consisting of 20 percent debt (based on market values) at a before-tax cost of 8 percent.UP will use the proceeds to repurchase stock at the new equilibrium market price. UP's marginal tax rate is 40 percent.It has earnings before interest and taxes (EBIT) of $2.5 million; it expects zero growth in EBIT, and it pays out all earnings as dividends.
- What is UP's current cost of equity?
- If the risk free rate is 2 percent and the market risk premium is 8 percent, what is UP's unlevered beta?
- What is the levered beta at the new capital structure of 20 percent debt?
- What is the new cost of equity under the capital structure financed with 20 percent debt?
- What is its new weighted average cost of capital?
- What is the new total corporate value of UP?
- What is the new stock price?
- How many shares remain outstanding after the recapitalization?
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