Question
Tonys Gelati has the following capital structure: $100 Million in debt with a beta of 0; $40 Million of Preferred Stock with beta 0.2; and
Tonys Gelati has the following capital structure: $100 Million in debt with a beta of 0; $40 Million of Preferred Stock with beta 0.2; and $200 Million of common stock with beta 1.2.
a) What is the firms asset beta?
b) How would the asset beta change if Tony issued an additional $140 Million of common stock and used the cash to repurchase all the debt and preferred stock?
c) Assuming CAPM, what discount rate should we use for investments that expand the scale of operations without changing the asset beta? Assume a risk premium of 8.6 and a treasury rate of 5.
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