A firm is currently financed with $400 of debt and $600 of equity. The expected return...

A firm is currently financed with $400 of debt and $600 of equity. The expected return on the debt is 5%. The market beta of the firmʹs equity is 1.2; the risk -free rate is 2%; and the equity premium is 6%. The firm pays taxes at the marginal rate of 40%. The firm is considering increasing its debt to $600 and using the funds to repurchase some of its stock. This is likely to change the expected return on debt to 7%. Using same WACC above, what will the new market beta of the firmʹs equity be? Round your answer to the nearest tenth.

a.1.0

b. Not determinable

c. 1.2

d. 1.4

Expert Solution

The beta calculated here does not match the option because nearest correct option is coming out to be 1.4 in the case that when the firm raised the debt but did not purchase the equity back but the question states that the debt raised would be used to purchase the equity, with the new capital structure the equity beta comes out to be 1.63 or something is missing in the question.

jeff jeffy answered 7 months ago

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