Question
Globe-Chem Co. has a capital structure that consists of 40% debt and 60% equity. The firm's current beta is 1.25, but managment wants to understand
Globe-Chem Co. has a capital structure that consists of 40% debt and 60% equity. The firm's current beta is 1.25, but managment wants to understand Globo-Chem Co.'s market risk without the effect of leverage. 1. If global-Chem has a 45% tax rate, what is its unlevered beta? a. 0.73 b. 0.82 c. 0.91 d. 1.09 Now consider this case of another company: U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before tax cost of debt is 8%. and its tax rate is 45%. It curerntly has a levered beta of 1.25. The risk-free rate is 2.5% and the risk premium on the market is 8%. U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax cost of debt in increase ton 10%. 2. First solve for the U.S. Robotics Inc's unlevered beta. a. 1.11 b. 1.21 c. 1.01 d. 0.91 3. Relever U.S. Robtics Inc's beta using the firm's new capital structure. a. 2.02 b. 1.66 c. 1.75 d. 1.84 4. Use U.S. Robtics Inc's levered beta under the new capital structure, to solve for its cost of equity under the new capital structure. a. 15.5% b. 13.8% c. 17.2% d. 19.8% 5. What will the firm's weighted average cost of capital be if it makes this change to its capital structure? a. 7.7% b. 10.2% c. 7.1% d. 8.7%
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