Problem solving

Kobe & Jason Inc. is financed entirely with 2,000,000 shares of common stock priced at $20 a share. The firm pays 100% of its earnings as dividends. EBIT is expected to be $5,000,000 for the foreseeable future. Ignore taxes (i.e., assume that the firm is operating in a perfect capital market with no taxes) and assume no growth.

a)What is the total market value of the firm?

b)What is the cost of equity?

c)The board of directors has decided to retire $10,000,000 common stock, replacing it with long-term debt that carries 9% annual interest.

(1)What will be the cost of equity after refinancing?

(2) What will be the weighted average cost of capital after refinancing?