Question

Problem 17-6 Leverage and the cost of capital Macbeth Spot Removers is entirely equity financed. Use the following information. Data Number of shares 1,000 Price per share $ 10 Market value of shares $ 10,000 Expected operating income $ 1,500 Macbeth now decides to issue $5,000 of debt and to use the proceeds to repurchase stock. Suppose that Ms. Macbeth's investment bankers have informed her that since the new issue of debt is risky, debtholders will demand a return of 12.5%, which is 2.5% above the risk-free interest rate. a. Recompute the return of assets (rA) and return on equity (rE)? (Do not round intermediate calculations. Round your answers to 3 decimal places.) Return on assets 0 Return on equity b. Suppose that the beta of the unlevered stock was .6. New capital structure is 50% debt financed. What will βA, βE, and βD be after the change to the capital structure? (Round your answers to 1 decimal place.) Asset beta Debt beta Equity beta

Answer 1