Anyone help me with this problem? Starting from number 3. According to the my te

Question

Anyone help me with this problem? Starting from number 3. According to the my text, if there is no debt, the D/E is zero, which means the current beta is also the unlevered beta. Without the unlevered beta, I can't solve the rest of the problem. Thanks!!

Currently, Bloom Flowers Inc. has a capital structure consisting of 30% debt and 70% equity. Bloom's debt currently has an 7% yield to maturity. The risk-free rate (rRF) is 5%, and the market risk premium (rM - rRF) is 8%. Using the CAPM, Bloom estimates that its cost of equity is currently 12%. The company has a 40% tax rate.

Bloom's financial staff is considering changing its capital structure to 40% debt and 60% equity. If the company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to 9.5%. The proposed change will have no effect on the company's tax rate.

Explanation / Answer

Current given beta is beta of levered equity, to calculate beta of levered equity use the equation, B(LE) = B(UE)*[1+D(1-tax)/E]. Check solution for further clearance.

(1)

(2)

(3)

(4)

(5)

Cost of equity, ke 12.00% cost of debt, kd [7%*(1-tax)] 4.2% Debt, wd 30% Equity, we 70% Wacc = wd*kd+we*ke 9.66%

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