The chairman of Slack decides that the company should increase the proportion of debt in its capital structure. Currently the company has 10% debt in its capital structure, and an equity beta of 0.8. The debt is considered risk free and yields an expected return of 5%, whereas the stock market expected return is 13%. The market capitalization of the company is currently $360 million. The chairman of Slack thinks that she can increase the proportion of debt to 60% by paying a one-time special dividend and issuing debt for the amount of this dividend. Then debt would have an expected return of 6%.

a. What is the debt beta, the asset beta, and the cost of capital of the company before the refinancing? What is the risk premium on the stock market?

b .What is the total value of the company before the recapitalization? What is the amount of debt issued and the dividend paid?

c. What is the beta of the common stock and debt after the refinancing? What is the required rate of return on the common stock after the refinancing?

d. How has the wealth of each individual shareholder changed? Assume that the debt is privately placed, so shareholders do not buy the debt issued.

e. Using the same assumptions as in 2.d, how has the beta of the portfolio of the holders of common stock changed as a result of the refinancing? How could the shareholders invest in the market portfolio to restore the risk of their portfolio to what it was before the refinancing?