Question

Best Bagels, Inc. (BB) currently has zero debt, an unleveraged firm. The firm has a total market value of $461,600. Management is considering recapitalizing by issuing enough debt so that the firm has a capital structure consisting of 30% debt and 70% equity, based on a market value at a before tax cost of 7%. Best Bagels will use the proceeds to repurchase stock at the new equilibrium market price. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. Its tax rate is 40%. The firm has 20,000 shares of common stock outstanding selling at a price per share of $23.08.

A) What is the BB's current cost of equity?

	13.00%
	12.68%
	11.56%
	14.95%
	15.76%

B) Based on the cost of common equity found problem 1, what is the BB's unlevered beta if the risk-free rate is 7% and the market risk premium is 5%?

	b = 1.0
	b = 1.1
	b = 1.2
	b = 1.3
	b = 1.4

C) Based on the BB's unlevered beta found in problem 2, what is the levered beta at the new capital structure of 30% debt?

	bL = 2.20
	bL = 1.51
	bL = 2.15
	bL = 2.25
	bL = 2.46

D) Based on the BB's levered beta found in problem 3, what is the new cost of equity under the capital structure financed with 30% debt?

	18.50%
	17.48%
	19.85%
	14.55%
	21.25%

E) Based on the BB's new cost of equity found in problem 4, what is its new weighted average cost of capital?

Answer 1