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An all equity firm is expected to generate perpetual EBIT of $100 million per year forever....

An all equity firm is expected to generate perpetual EBIT of $100 million per year forever. The corporate tax rate is 35%. The firm has an unlevered (asset or EV) Beta of 0.8. The risk-free rate is 4% and the market risk premium is 6%. The number of outstanding shares is 10 million.

The firm decides to replace part of the equity financing with perpetual debt. The firm will issue $100 million of permanent debt at the riskless interest rate of 4%, and use this $100 million of proceeds to repurchase the same amount of common stock.

1. Calculate the new cost of equity, and the new WACC following this capital structure change. Also calculate the new equity Beta using the tax version of the formula, and assume a zero debt Beta.

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