BEA is considering a change it its capital structure. BEA currently has $20 mill
ID: 2800124 • Letter: B
Question
BEA is considering a change it 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 faces a 40% tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values. BEA has a current cost of equity of 9%.
a. What is BEA’s current levered beta?
b. What is BEA’s unlevered beta?
c. What would be BEA’s estimated cost of equity if it were to change its capital structure to 40 percent debt and 60 percent equity?
Explanation / Answer
Answer to Part a)
Cost of Equity = Risk Free rate + Beta * Risk Premium
0.09 = 0.06 + (Beta * 0.04)
0.03 = 0.04 * Beta
Leverad Beta = 0.75
Answer to Part b)
Unlevered Beta = Levered Beta / [1 + (1 - Tax Rate) * D/E]
Debt to Equity ratio = 0.20 / 0.80 = 0.25
Unlevered Beta = 0.75 / [ 1 + (1 - 0.40) * 0.25]
Unlevered Beta = 0.75 / [1 + 0.15]
Unlevered Beta = 0.75 / 1.15
Unlevered Beta = 0.65
Answer to Part c)
Unlevered Beta = Levered Beta / [1 + (1 - Tax Rate) * D/E]
Debt to Equity ratio = 0.40 / 0.60 = 0.67
0.65 = Levered Beta / [ 1 + (1 - 0.40) * 0.67]
0.65 = Levered Beta / [1 + 0.402]
0.65 = Levered Beta / 1.402
Levered Beta = 0.91
Cost of Equity = Risk Free rate + Beta * Risk Premium
Cost of Equity = 6% + 0.91 * 4%
Cost of Equity = 9.64%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.