The Aquis Ltd is distributor of electronic goods. Last year sales were Rs 11,00,000, fixed costs were 40,000 and variable

costs were 60% of sales with an EBIT of Rs 4,00,000. The company is expecting consistent EBIT for near future. It pays out

all its earnings as dividends. Assets are Rs 2 Mn, and it had issued 80,000 shares which are currently selling at Rs 25 per

share with P/B ratio of one. The management owns about 50% of the stock.

At present it is an all-equity firm. The owners of the company feel that they can increase the value of the firm by having some

debt in the capital structure as company pays almost 30% tax. They are planning to recapitalize with Rs 2,50,000 of debt at

the risk-free rate. The risk-free rate is 6%, market risk premium is 7%. The unlevered beta is 1.0 and its cost of equity is 12%.

Based on above information, answer the following questions,

a) Using Hamada equation, what will be the cost of equity if the company recapitalizes with above debt?

b) What would be the share price if the company recapitalizes with above debt?

c) It is assumed above that the business risk of the firm will be same. But what will be effect of business risk on the

EPS and thereby on price of the share under following situations assuming company would like to maintain its return

to investors under all situations,

Prob. EBIT

0.25 2,00,000

0.50 3,00,000

0.25 4,00,000

The recapitalization is same as above. What will be the average and standard deviation of share price?