Question
KRJ Enterprises (KRJ) is a zero-growth company so its after-tax operating earnings will equal its free cash flows. It currently has zero debt and its
KRJ Enterprises (KRJ) is a zero-growth company so its after-tax operating earnings will equal its free cash flows. It currently has zero debt and its earnings before interest and taxes (EBIT) are $9,164. Its current cost of equity is 12% and its tax rate is 29%. The firm has 1,000 shares of common stock outstanding selling at a price of $48 per share. KRJ is considering changing its capital structure to one with 21% debt and the remainder equity, based on market values. The debt would have an interest rate of 7%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the added leverage would cause the required rate of return on equity to rise to 14%. If this plan were carried out, by how much would the value of the firm be expected to change? Please show all calculations.
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