Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

(5 points) In t=0, Sanoti Ltd. is an unlevered company whose Beta is 2. The market return is 6%. The risk-free rate is 4%. To

image text in transcribed

(5 points) In t=0, Sanoti Ltd. is an unlevered company whose Beta is 2. The market return is 6%. The risk-free rate is 4%. To begin with, assume that capital markets are perfect and Modigliani-Miller assumptions hold true. (a) Determine the required cost of equity using CAPM. (b) Given your answer in part (a), suppose that in t=1 Sanoti does a leveraged recapitalization, issuing risk-free debt and repurchasing stocks until its debt-equity ratio is 0.5. The rate of return on debt is 4% and the corporate tax rate is zero (c=0). i. Will the WACC of GAM change after the recapitalization? Explain why in max 2 lines. ii. What is the cost of equity of the levered firm? Briefly discuss your answer (max 2 lines). (c) In t=2, the government increases the corporate tax rate to 20%. If the debt-equity ratio is still 0.5, compute the (after-tax) WACC. (5 points) In t=0, Sanoti Ltd. is an unlevered company whose Beta is 2. The market return is 6%. The risk-free rate is 4%. To begin with, assume that capital markets are perfect and Modigliani-Miller assumptions hold true. (a) Determine the required cost of equity using CAPM. (b) Given your answer in part (a), suppose that in t=1 Sanoti does a leveraged recapitalization, issuing risk-free debt and repurchasing stocks until its debt-equity ratio is 0.5. The rate of return on debt is 4% and the corporate tax rate is zero (c=0). i. Will the WACC of GAM change after the recapitalization? Explain why in max 2 lines. ii. What is the cost of equity of the levered firm? Briefly discuss your answer (max 2 lines). (c) In t=2, the government increases the corporate tax rate to 20%. If the debt-equity ratio is still 0.5, compute the (after-tax) WACC

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Behavioural Approaches To Corporate Governance

Authors: Cameron Elliott Gordon

1st Edition

1138611395, 978-1138611399

More Books

Students also viewed these Finance questions