HD Industries (HDI) has been constrained by the high cost of capital to make many capital investments. You are provided with the following information:

1. The current price of HDIs 7% coupon, annual payment, non-callable bonds with 18 years remaining to maturity is $1,100. There are no flotation costs.

2. The current value of the firms 6%, $25 par value, quarterly dividend, perpetual preferred stock is $19.74. HDI would incur flotation costs equal to 6% of the proceeds on a new issue.

3. HDIs beta is 1.2, the yield on government bonds is 4% and the market risk premium is estimated to be 5%.

4. The company has a target capital structure of 35% debt, 5% preferred shares and 60% common equity.

5. Tax rate = 30%

a) What is HDIs weighted average cost of capital (WACC)?

b) Now suppose HDI has no preferred shares and only has debt of $2 million and 600,000 common shares outstanding at $30/share price. What is HDIs total market value? (2 marks)

c) What is HDIs new WACC based on part (b) above? Assume cost of debt and cost of equity is the same as calculated in Part (a) above.

d) HDI buys another company, NMI Co. NMI is currently financed with 30% debt and 70% equity. HDI is considering that NMI should increase its level of debt until it is financed with 60% debt and 40% equity. The beta on NMIs common stock at the current level of debt is 1.3, the risk-free rate is 5% and the market risk premium is 4%. NMIs tax rate is same as HDI.

i. What is NMIs current cost of equity?

ii. What is NMIs unlevered beta?

iii. What will be the new beta (levered) and new cost of equity if NMI recapitalizes?