Question

Indell stock has a current market value of $80

million and a beta of 1.40. Indell currently has​ risk-free debt as well. The firm decides to change its capital structure by issuing $33.26

million in additional​ risk-free debt, and then using this $33.26

million plus another $9 million in cash to repurchase stock. With perfect capital​ markets, what will the beta of Indell stock be after this​ transaction?

Answer 1

current market value , c= $80 million

net debt value after new debt , d= new debt + cash paid to repurchase stock = $33.26 + 9 = $42.26 million

new equity value after new debt issue, e = c - d = 80-42.26 = $37.74 million

current beta , b1 = 1.40

since the debt is risk free , the debt beta will be zero and the new levered beta(b2) will be calculated as follows:

b2 = b1*(1+(d/e)) = b1*((e+d)/e) = b1*(c/e)

b2 = 1.4*(80/37.74) = 2.96767 or 2.97 ( rounding off to 2 decimal places)

beta after this transaction = b2 = 2.97