uantitative Problem: Currently, Meyers Manufacturing Enterprises MME) has a capi

Question

uantitative Problem: Currently, Meyers Manufacturing Enterprises MME) has a capital structure consisting of 35% debt and 65% equity MME's debt currently has a 49 yield to maturity. The risk-free rate (rRF) is 5.4%, and the market risk premium (rM-TRF) is 64%, using the CAPM, MME estimates that ts cost of equity s umenty 24%. The company has a 40% tax rate. a. What is MME's current WACC? Round your answer to 2 decimal places. Do not round intermediate calculations. b. What is the current beta on MME's common stock? Round your answer to 4 decimal places. Do not round intermediate calculations c. What would MME's beta be if the company had no debt in its capital structure? (That is, what is MME's unlevered beta, bu?) Round your answer to 4 decimal places. Do not round intermediate calculations. marun MME's financial staff is considering changing its capital structure to 45% debt and 55% equity If the company went ahead wth the proposed change the ye the company's bonds would rise to 7.9%. The proposed change will have no effect on the company's tax rate d. What would be the company's new cost of equity if it adopted the proposed change in capital structure? Round your answer to 2 decimal places. Do not round intermediate calculations. e. What would be the company's new WACC if it adopted the proposed change in capital structure? Round your answer to 2 decimal places. Do not round intermediate f. Based on your answer to Part e, would you advise MME to adopt the proposed change in capital structure? Select

Explanation / Answer

1
WACC=proportion of debt*cost of debt*(1-tax rate)+proportion of equity*vost of equity
=35%*7.4%*(1-40%)+65%*12.4%
=9.614%

2
Cost of equity=risk free+beta*market risk premium
Given, cost of equity=12.4%
Hence, 12.4%=5.4%+beta*6.4%
=>beta=7/6.4=1.09375

3
Unlevered beta=levered beta/(1+(1-tax rate)*Debt/Equity)
=1.09375/(1+(1-40%)*35%/65%)
=0.826672

4
Levered beta=unlevered beta*(1+(1-tax rate)*Debt/Equity)
=0.826672*(1+(1-40%)*45%/55%)
=1.232493

New Cost of equity=risk free+beta*market risk premium
=5.4%+1.232493*6.4%
=13.288%

5
WACC=45%*7.9%*(1-40%)+55%*13.288%
=9.4414%

6
As WACC has decreased, the company should adopt this capital structure

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