Question 1 (2 Marks) Grey Berhad's target capital structure is 25 % debt, 10 % preferred stock, and 65 % common stock. Assume that the firms after-tax yield to maturity on its bond is 6 % and that the investors require a 7.5 %t return on Grey preferred stock and a 15 % return on its common stock. What is Grey Berhads weighted average cost of capital (WACC)? Question 2 (4 Marks) Merah Berhad has made the following forecast for the upcoming year based on the companys current capitalization: Interest expense RM2,000,000 Operating income (EBIT) RM40,000,000 Earnings per share RM4.00 The company has RM20,000,000 worth of debt outstanding and all of its debt yields 10 %. The companys tax rate is 30%. The companys price-earnings (P/E) ratio has traditionally been 10. The companys investment bankers have suggested that the company recapitalize. Their suggestion is to issue enough new bonds at a yield of 10% to repurchase 1,400,000 shares of common stock. Assume that the repurchase will have no effect on the companys operating income; however, the repurchase will increase the companys dollar interest expense. Also, assume that as a result of the increased financial risk, the companys price-earnings (P/E) ratio will be 10.5x after the repurchase. Required:

a) What is the net income before the change?

b) How many shares are currently outstanding?

c) What is the current stock price?

d) What would be the expected year-end stock price if the company proceeded with the recapitalization? Should Merah Berhad proceed with the recapitalization?