pam Corp. is financed entirely by common stock and has a beta of 1.45. The firm

Question

pam Corp. is financed entirely by common stock and has a beta of 1.45. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price-earnings ratio of 5.23 and a cost of equity of 19.12%. The company’s stock is selling for $34. Now the firm decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free, with a 4.5% interest rate. The company is exempt from corporate income taxes. Assume MM are correct.

a.

Calculate the cost of equity after the refinancing. (Round your answer to 2 decimal places.)

  Cost of equity %

b.

Calculate the overall cost of capital (WACC) after the refinancing. (Round your answer to 2 decimal places.)

  Cost of capital %

c. Calculate the price-earnings ratio after the refinancing.(Round your answer to 2 decimal places.)

  Price-earnings ratio   

d. Calculate the stock price after the refinancing.

  Stock price $   

e. Calculate the stock’s beta after the refinancing. (Round your answer to 1 decimal place.)

  Stock's beta   

Explanation / Answer

a. After refiancing, the Equity weight = Debt weight = 0.5

So, 0.5*Re + 0.5*4.5 = 19.12 where Re is the cost of equity

Re = 16.87/0.5 =33.74%

Cost of equity =33.74$

b. The overall WACC after refinancing will continue to be at 19.12% . So WACC = 19.12%

c. Re = E/R = 33.74% = 0.3374. The P/E ratio = 1/0.3374 = 2.96

d. Stock Price =$34 (remains same)

e. Let stock beta = Be

So, 0.5* 0 + 0.5*Be = 1.45

Be = 2.9

So Stock beta = 2.9

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