If the company were to recapitalize, debt would be issued, and the funds received would be used to repurchase stock. Bernies is in the 25 percent state-plus-federal corporate tax bracket, its unlevered beta is 0.85, the risk-free rate is 3.5 percent, and the market risk premium is 6.5 percent.

The companys EBIT was $500 million last year and is expected to grow at a rate of 3% per year forever. The firm is currently financed with all equity and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firms investment banker the following estimated costs of debt for the firm at different capital structures:

%Debt rd

0%

20% 7.25%

30% 7.75%

40% 9.00%

50% 11.75%

a) For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC.

b Now calculate the corporate value for each capital structure.

c) Also, calculate the value of the debt and equity of the firm.