Question

The CBA Corporation is considering a change in its capital structure. They currently have $10 million (market value) in debt at an interest rate of 5.6%. Their stock price is $35 per share with 1,000,000 shares outstanding. EBIT is currently $6.15 million and is expected to remain at that level into the foreseeable future. The risk-free rate is currently 3.2% and the market risk premium is 5.8%. CBA has a beta of 1.1. They are in the 40% combined federal and state tax bracket. CBA is considering increasing its debt ratio to 50% based on market values. They will repurchase existing shares of stock with the money that they borrow. If CBA borrows the additional money, the rate of interest on all debt will increase to 7%. What is CBA’s unlevered beta using market value D/S? What will be CBA’s new beta and cost of common stock, rs,under the proposed 50% debt ratio? What are CBA’s WACC, total value of the firm, and price per share under the new capital structure? What will be the change in CBA’s EPS due to the proposed restructuring?

Answer 1