Question:

Currently, BYCO Inc. has a capital structure consisting of 20% debt and 80% equity. BYCOs debt currently has an 8% yield to maturity. The risk-free rate (rRF) is 5%, and the market risk premium (rM rRF) is 6%. Using the CAPM, Bloom estimates that its cost of equity is currently 12.5%. The company has a 30% tax rate.

1. What is BYCOs current WACC?
2. What is the current beta on BYCOs common stock?
3. What would BYCOs beta be if the company had no debt in its capital structure? (That is, what is BYCOs unlevered beta, bU?)

BYCOs financial staff is considering changing its capital structure to 40% debt and 60% equity. If the company went ahead with the proposed change, the yield to maturity on the companys bonds would rise to 9.5%. The proposed change will have no effect on the companys tax rate.

1. What would be the companys new cost of equity if it adopted the proposed change in capital structure?
2. What would be the companys new WACC if it adopted the proposed change in capital structure?

Based on your answer to Part e, would you advise BYCO to adopt the proposed change in capital structure? Explain

Course: (Financial Management And Application)