Flood Motors is an all-equity firm (Debt ratio = 0%) with 200,000 shares outstanding, with current WACC of 10%.

The risk-free rate in the economy is 6 %, the market risk premium is 4 % and the companys tax rate is 40 percent.

The company is considering issuing $2 million worth of bonds (at par) and using the proceeds for a stock repurchase. This will create a debt ratio of 25% in the company.

If issued, the bonds would have an estimated yield to maturity (rd before tax) of 8.0%, also this is expected to raise the EPS from a current of $2.34 to $3.45 and companys beta would rise to 1.2 if it proceeds with the recapitalization.

Required: Use the given above to answer questions 1 through 8

1- Before the recapitalization, what is the companys cost of common equity (rs)? *

0%

14%

6%

10%

None of the above

2- Before the recapitalization, what is the companys stock beta (Bu)? *

2.00

1.20

1.75

2.34

None of the above

3- After the recapitalization, what is the companys cost of common equity (rs)? *

10.8%

11.2%

10%

8%

None of the above

4- After the recapitalization, what is the companys WACC? *

11.2%

9.3%

8.0%

10%

None of the above

5- After the recapitalization, what is the companys stock price (P0)? *

$52.64

$45.49

$28.54

$23.46

None of the above

6- If the company used a debt for 50% with 9% YTM (before tax cost of debt), then the WACC compared to WACC with no debt will: *

Increase by 12%

Increase by 50%

Decrease by 0.5%

Decrease by 1.1%

None of the above

7- If the company has a target WACC of 9%, knowing that it can issue bonds at rate of 8% and maintain Beta leverage 1.15, how much approximately it should use debt as portion of its total capital to meet its target? *

15.0%

27.5%

34.0%

55.5%

None of the above

8- Assume the company needs to maintain a price per share $40 with EPS 12% from the price and a cost of capital no more than 8%, knowing that the company can borrow at any level of debt at an interest rate before tax 9.5%. Then how much should be the approximate level of equity for the company to reach its target. *

47.62%

52.38%

65.92%

70.28%

e) None of the above