Consider a firm that currently has no debt. The risk free rate is 3%, the market

Question

Consider a firm that currently has no debt. The risk free rate is 3%, the market risk premium is 6%, and the firm carries a beta of 2. Assume no taxes or transaction costs and perfect capital markets (i.e. Modigliani-Miller).

a) What is the weighted average cost of capital for this firm? WACC = .15

b) If the firm currently has a valuation of $10 million, what is the market value of debt and equity if the firm issues 1-year zero coupon riskless debt with face value of $4.12 million and uses the proceeds to repurchase stock? Debt: $4M Equity: $6M

c) What is the beta for the firm after this change in capital structure?

Explanation / Answer

d) Levered Beta = Unlevered Beta x (1 + ((1

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