Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

*PLEASE ANSWER D AND E, I ANSWERED A/B/C Increasing financial leverage increases both the cost of debt (r debt ) and the cost of equity

*PLEASE ANSWER D AND E, I ANSWERED A/B/C

Increasing financial leverage increases both the cost of debt (rdebt) and the cost of equity (requity). So the overall cost of capital cannot stay constant. This problem is designed to show that the speaker is confused. Buggins Inc. is financed equally by debt and equity, each with a market value of $1 million. The cost of debt is 5%, and the cost of equity is 10%. The company now makes a further $250,000 issue of debt and uses the proceeds to repurchase equity. This causes the cost of debt to rise to 5.5% and the cost of equity to rise to 10.83%. Assume the firm pays no taxes.

A. How much debt does the company now have? $1,250,000

B. How much equity does it now have? $750,000

C. What is the overall cost of capital? 7.5%

D. What is the percentage increase in earnings per share after the refinancing? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

E. What is the new price-earnings multiple? (Hint: Has anything happened to the stock price?) (Round your answers to 2 decimal place.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Surviving In General Management

Authors: Philip Berman, Pauline Fielding

1st Edition

9780333483145

More Books

Students also viewed these Finance questions

Question

What are the DBAs database design responsibilities?

Answered: 1 week ago