Question
2. Company ABC is financed entirely by common stock and has a beta of 1.5. ABC is expected to generate a constant and perpetual stream
2. Company ABC is financed entirely by common stock and has a beta of 1.5. ABC is expected to generate a constant and perpetual stream of earnings and dividends. Its stock has a price-earnings ratio of 8 and a cost of equity of 12.5%. Currently, its stock price is traded at $50. Now, ABC decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free with a 5% interest rate. Assume that the company is exempt from corporate income taxes. If Modigliani and Miller are correct, calculate the following items after the refinancing: a. The cost of equity b. The total cost of capital c. The price-earnings ratio d. The stock price e. The stocks beta
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