Question
XOM is considering a change in its capital structure. XOM will increase its debt level to a capital structure with 50% debt and repurchase shares
XOM is considering a change in its capital structure. XOM will increase its debt level to a capital structure with 50% debt and repurchase shares with the extra money that it borrows. XOM will retire old debt to issue new debt, and the rate on the new debt will be 11%. XOM currently has $40M in debt carrying a rate of 9%, and its stock price is $30 per share with 4 million shares outstanding. XOM is a zero-growth firm and pays all its earnings as dividends. The firms EBIT is $40 million, and its tax rate is 35%. The market return is 13% and risk-free rate is 4%. XOM has a beta of 1.6.
a) What is the XOMs unlevered beta? In all beta levering and un-levering steps apply Hamada Equation.
b) What are XOMs new beta and cost of equity if it has 50% debt?
c) What are XOMs WACC and total firm value with 50% of debt?
d) What is the premium for financial risk attached to Nevada Inc.s equity, given its leverage ratio is 50%? You can use your results from parts (a) and (b) to answer part (d).
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