An unlevered firm has an asset market beta of 1.5. The risk-free rate is 3%. The equity
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An unlevered firm has an asset market beta of 1.5. The risk-free rate is 3%. The equity premium is 4%.
(a) What is the firm’s cost of capital?
(b) The firm refinances itself. It repurchases half of its stock with debt that it issues.
Assume that this debt is risk free. What is the equity beta of the levered firm?
(c) According to the CAPM, what rate of return does the firm have to offer to its creditors?
(d) According to the CAPM, what rate of return does the firm have to offer to its levered equity holders?
(e) Has the firm’s weighted average cost of capital improved?
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