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Edison is currently an all-equity firm with an expected return of 12%. Edison's firm value is...
| Edison is currently an all-equity firm with an expected return of 12%. Edison's firm value is $500m. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. Assume that there are no coporate taxes, no market frictions and no bankruptcy costs. Make sure to read all questions below (4 questions each worth 15 points) | ||||||||
| Q1 (15 points) | Suppose Edison wants to borrow to the point that its debt-equity ratio is 0.50. What is the value of the debt that is issued by Edison? What is the value of the remaining equity if the proceeds from the debt issuance are used to repurchase shares of common stock? | |||||||
| Q2 (15 points) | Suppose Edison wants to borrow to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital will be 6%. What will be the expected return of equity be after this transaction? | |||||||
| Q3 (15 points) | Suppose instead that Edison borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Edison's debt will be much riskiers. As a result, the debt cost of capital will be 8%. What will be the expected return of equity in this case? | |||||||
| Q4 (15 points) | A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to the argument? | |||||||
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jeff jeffy answered 1 year agoRelated Solutions
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