Yerba Industries is anall-equity firm whose stock has a beta of 1.00 and an expected return of 13%. Suppose it issues newrisk-free debt with a 7% yield and repurchase 60% of its stock. Assume perfect capital markets.

a. What is the beta of Yerba stock after thistransaction?

The beta of Yerba stock after this transaction is ................. (Round to two decimalplaces.)

b. What is the expected return of Yerba stock after thistransaction?

The expected return of Yerba stock after this transaction is ...............%. (Round to two decimalplaces.)

Suppose that prior to thistransaction, Yerba expected earnings per share this coming year of $4.00, with a forwardP/E ratio(that is, the share price divided by the expected earnings for the comingyear) of 12.

c. What isYerba's expected earnings per share after thistransaction? Does this change benefit theshareholder? Explain.

If prior to thetransaction, Yerba expected earnings per share this coming year of $4.00, with a forwardP/E ratio of 12, Yerba's expected earnings per share after this transaction is $............. (Round to the nearestcent.)

Does this change benefit theshareholder? Explain.(Select the best choicebelow.)

A.It does not benefit shareholders because if you take into account the shares they lost to therepurchase, their cash flows are actually the same.

B.It does not benefit shareholders because the risk of holding equity has increased.

C.You cannot tell. It depends on shareholders risk preferences. Cash flows arehigher, but so isrisk, some shareholders will be betteroff, some will be worse off.

D.It does benefit shareholders because their cash flows have gone up and everything else is unchanged.

d. What isYerba's forwardP/E ratio after thistransaction? Is this change in theP/E ratioreasonable? Explain.

Yerba's forwardP/E ratio after this transaction is ................ (Round to two decimalplaces.)

Is this change in theP/E ratioreasonable? Explain.(Select the best choicebelow.)

A.It is reasonable.P/E has gone down because risk has gone up.

B.You cannot tell. It depends onshareholders' risk preferences.P/E has gonedown, but risk has alsochanged, some shareholders will be betteroff, some will be worse off.

C.It is reasonable.P/E has gone down because risk has gone down.

D.It is not reasonable and reflects the value loss of the recapitalization.