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CAPITAL STRUCTURE PROBLEM The following data reflect a firm's condition. current financial Value of debt (book value=market value) $ 5,000,000 Market value of equity (P.

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CAPITAL STRUCTURE PROBLEM The following data reflect a firm's condition. current financial Value of debt (book value=market value) $ 5,000,000 Market value of equity (P. x shares) $ 25,000,000 Total value of firm $ 30,000,000 EBIT $ 5,500,000 Tax Rate (T) 40% At the current level of debt, the cost of debt (k) is 100 and the firm's beta = 1.5. The firm is questioning the possibility of issuing $1,500,000 of additional debt and using the proceeds to repurchase stock. If it does, the interest on new debt would rise to 12t and beta would rise to 2.0. (The old 10debt would remain outstanding.) E[R] = 10% and R, = 63. (1) Calculate the value of the firm at the higher level of debt and decide if the firn should increase its debt to $6,500,000. The market price of the firm's stock was originally $25.00. Calculate the new stock price (P') at a debt level of $6,500,000. Calculate the value of EPS under the original debt level of $5,000,000 and its value under the higher debt level of $6,500,000. (4) How does your answer to (3) influence the decision you made in answering (1)? EXPLAIN! (5) Calculate the WACC, ka, at the original debt level of $5,000,000. (6) Calculate the WACC, ka $6,500,000 at the new debt level of (7) Do the results of (5) and (6) above contradict or support the decision you made in answering (1)? EXPLAIN

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