Question

Currently, Forever Flowers Inc. has a capital structure consisting of 30% debt and 70% equity. Forever's debt currently has an 7% yield to maturity. The risk-free rate (r_RF) is 4%, and the market risk premium (r_M- r_RF) is 8%. Using the CAPM, Forever estimates that its cost of equity is currently 12%. The company has a 40% tax rate. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations.

Open spreadsheet

Recapitalization
% debt in original capital structure, wd	30.00%
% common equity in original capital structure, wc	70.00%
Yield to maturity on debt, rd	7.00%
Risk-free rate, rRF	4.00%
Market risk premium (rM - rRF)	8.00%
Cost of common equity, rs	12.00%
Tax rate	40.00%
% debt in new capital structure, wd New	40.00%
% common equity in new capital structure, wc New	60.00%
Changed yield to maturity on debt, rd New	10.00%
Current WACC calculation:			Formulas
WACC			#N/A
Current beta calculation:
Levered beta, bL			#N/A
Unlevered beta calculation:
bU			#N/A
Cost of equity calculation with changed capital structure:
Levered beta, bL			#N/A
Cost of equity with new capital strucutre, rs New			#N/A
WACC calculation with new capital structure:
WACC New			#N/A
Recommendation on capital structure:			#N/A
Change or Do Not Change

1. What is Forever's current WACC? Round your answer to two decimal places.

   %

2. What is the current beta on Forever's common stock? Round your answer to two decimal places.

3. What would Forever's beta be if the company had no debt in its capital structure? (That is, what is Forever's unlevered beta, b_U?) Round your answer to two decimal places.

   Forever's financial staff is considering changing its capital structure to 40% debt and 60% equity. If the company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to 10%. The proposed change will have no effect on the company's tax rate.

4. What would be the company's new cost of equity if it adopted the proposed change in capital structure? Round your answer to two decimal places.

   %

5. What would be the company's new WACC if it adopted the proposed change in capital structure? Round your answer to two decimal places.

   %

6. Based on your answer to part e, would you advise Forever to adopt the proposed change in capital structure?

Recapitalization
% debt in original capital structure, wd	30.00%
% common equity in original capital structure, wc	70.00%
Yield to maturity on debt, rd	7.00%
Risk-free rate, rRF	4.00%
Market risk premium (rM - rRF)	8.00%
Cost of common equity, rs	12.00%
Tax rate	40.00%
% debt in new capital structure, wd New	40.00%
% common equity in new capital structure, wc New	60.00%
Changed yield to maturity on debt, rd New	10.00%
Current WACC calculation:			Formulas
WACC			#N/A
Current beta calculation:
Levered beta, bL			#N/A
Unlevered beta calculation:
bU			#N/A
Cost of equity calculation with changed capital structure:
Levered beta, bL			#N/A
Cost of equity with new capital strucutre, rs New			#N/A
WACC calculation with new capital structure:
WACC New			#N/A
Recommendation on capital structure:			#N/A
Change or Do Not Change

Answer 1

What is Forever's current WACC? Round your answer to two decimal places.
=proportion of debt*yield to maturity*(1-tax rate)+proportion of equity*cost of equity
=30%*7%*(1-40%)+70%*12%
=9.66%

What is the current beta on Forever's common stock? Round your answer to two decimal places.
=(cost of equity-risk free rate)/market risk premium
=(12%-4%)/8%
=1.000

What would Forever's beta be if the company had no debt in its capital structure? (That is, what is Forever's unlevered beta, bU?) Do not round intermediate calculations. Round your answer to two decimal places.
=Current beta/(1+(1-tax rate)*Debt/Equity)
=1.000/(1+(1-40%)*30%/70%)
=0.795

What would be the company's new cost of equity if it adopted the proposed change in capital structure? Do not round intermediate calculations. Round your answer to two decimal places.
=risk free rate+New beta*market risk premium
=4%+0.795*(1+(1-40%)*40%/60%)*8%
=12.91%

What would be the company's new WACC if it adopted the proposed change in capital structure? Do not round intermediate calculations. Round your answer to two decimal places.
=proportion of debt*yield to maturity*(1-tax rate)+proportion of equity*cost of equity
=40%*10%*(1-40%)+60%*12.91%
=10.15%

Based on your answer to part e, would you advise Forever to adopt the proposed change in capital structure?
No