Brown Inc. is considering changing its capital structure. Brown currently has $100 million in debt that carries a 6% interest rate. Its stock currently sells for $25 a share and there are 20 million shares outstanding. Brown is a zero growth firm and pays out all its earnings as dividends. Brown%u2019s EBIT is $20 million and the tax rate is 35%. The risk-free rate is 3% and the market risk premium is 5%. Brown is considering increasing its debt to 40% and buying back stock with the money it raises. New debt could be sold for 8%. Brown%u2019s beta is currently 1.2.
a. What is Brown%u2019s unlevered beta?
b. What will the beta and the cost of equity be after the recapitalization?
c. What is the WACC before and after the capital structure change. Should Brown increase their debt to 40%?