Question

Honeywell has expected earnings of $854,000 and a market value of equity of $10,600,000. The firm is planning to issue $3,200,000 of debt at 5 percent interest and use the proceeds to repurchase shares at their current market value. Ignore taxes. What will be the cost of equity after the repurchase?

Answer 1

	Before Debt	After Debt
Expected earnings	$                     854,000	$              854,000
Interest, 3200000*5%	$                               -	$              160,000
Earning after Interest	$                     854,000	$              694,000
Market value of equity	$                10,600,000	$           7,400,000
Cost of equity	Earning after tax/Market value of equity
Cost of equity	854000/10600000	694000/7400000
Cost of equity	8.06%	9.38%