If a firm plans on reducing the level of debt in their capital structure, then t
ID: 2705091 • Letter: I
Question
If a firm plans on reducing the level of debt in their capital structure, then this should cause the cost of debt to ___________ and the cost of equity to ___________.
a) Fall; Fall b) Fall; Rise c) Rise; Rise d) Rise; Fall
Use the following information for questions 1-7. A corporation has 6,000,000 shares of stock outstanding at a price of $30 per share. They just paid a dividend of $3 and the dividend is expected to grow by 5% per year forever. The stock has a beta of 1.2, the current risk free rate is 6%, and the market risk premium is 7%. The corporation also has 400,000 bonds outstanding with a price of $1080 per bond. The bond has a coupon rate of 9% with semiannual interest payments, a face value of $1,000, and 13 years to go until maturity. However, it can be called in 6 years for a call premium of $1,050. The company plans on paying off their debt until they reach their target debt ratio of 40%. They expect their cost of debt to be 7% and their cost of equity to be 12% under this new capital structure. The tax rate is 40%
1. What is the required return on the corporation
Explanation / Answer
Use the following information for questions 1-7. A corporation has 6,000,000 shares of stock outstanding at a price of $30 per share. They just paid a dividend of $3 and the dividend is expected to grow by 5% per year forever. The stock has a beta of 1.2, the current risk free rate is 6%, and the market risk premium is 7%. The corporation also has 400,000 bonds outstanding with a price of $1080 per bond. The bond has a coupon rate of 9% with semiannual interest payments, a face value of $1,000, and 13 years to go until maturity. However, it can be called in 6 years for a call premium of $1,050. The company plans on paying off their debt until they reach their target debt ratio of 40%. They expect their cost of debt to be 7% and their cost of equity to be 12% under this new capital structure. The tax rate is 40%
1. What is the required return on the corporation
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