Beckman Engineering and Associates (BEA) is considering a change in its capital

Question

Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. The firm's EBIT is $12.753 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 5%, and the risk-free rate is 5%. BEA is considering increasing its debt level to a capital structure with 45% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 10%. BEA has a beta of 1.2.

A) What is BEA's unlevered beta before restructuring? Use market value D/S (which is the same as wd/ws) when unlevering. Round your answer to two decimal places.

B)What are BEA's new beta after releveraging and cost of equity if it has 45% debt? Round your answers to two decimal places.

C)What is BEA's WACC after releveraging? Round your answer to two decimal places.
_______%

D) What is the total value of the firm with 45 % debt? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ ________ million

Explanation / Answer

BEA currently has in debt= D=$20 million, cost of Debt=8%, and its stock price = $40 per share ,shares o/s= 2 million shares outstanding. BEA is a zero growth=>g=0%,equity=E= $40 per share * 2 million shares outstanding=$80 million

total capital=debt+equity=$20 million+$80 million=$100 million

firm's EBIT = $12.753 million, The market risk premium= 5%, and the risk-free rate =5%,BEA has a beta =1.2.,TaxRate=40%

BEA's unlevered beta before restructuring=beta(levered)/(1+(D/E)*(1-TaxRate)) = 1.2/(1+(20/80)*(1-.40)) =1.2/1.15=1.044

B)New debt value=.45*capital=.45*100=$45 million and E=$55 million

BEA's new beta after releveraging=BEA's unlevered beta*((1+(D/E)*(1-TaxRate))=1.044*((1+(45/55)*(1-.4))=1.56

cost of equity= the risk-free rate+BEA's new beta*(market risk premium)=5%+1.56*5%=12.80%

C)Wacc =%Debt*new cost of Debt*(1-tax rate)+cost of equity after releveraging*%Equity

Wacc =.45*10%*(1-.4)+12.8%*.55= .45*.10*(1-.4)+.128*.55= 0.0974 or 9.74%

D)Total value of firm=EBIT(1-taxRate)/Wacc= $12.753*.6 million/.0974=7.6518/.0974=$78.56million

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.