Question

Trident Co. is considering a change in its capital structure. Trident currently has $10 million in debt, and its stock price is $7.50 per share with 4 million shares

outstanding. Trident is a zero growth _rm and pays out all of its earnings as dividends.

It has no depreciation, no working capital investments, no capital expenditure, and no

non-operating assets. Trident's annual EBIT is $5 million, and it is constant forever.

It faces a 35% tax rate. The market risk premium is 5%, and the risk-free rate is 3%.

Trident is considering increasing its debt level to a capital structure with 45% debt,

based on market values, and repurchasing shares with the extra money that it borrows.

Trident will have to retire the old debt in order to issue new debt, and the yield on the

new debt will be 8%. Currently Trident has a beta of 1.4.

(a) What is Trident's unlevered beta?

(b) What are Trident's new beta and cost of equity if it has 45% debt?

(c) What are Trident's WACC and total value of the _rm with 45% debt?

Answer 1