Question

- A firm is considering recapitalization, and will estimate the cost of equity with theHamada equation. The firm is able to buy back stock at the current market price. That is, if the firm obtains $X million in new debt, it can buy back $X million of common stock.

The current amount of debt is $60 million and r_{D} =
8%. The current amount of equity is $200 million.

The firm’s current ß = 1.2. The tax rate is
40%. We observe r_{RF} = 6% and
r_{M} = 16%.

Calculate the cost of equity if the firm takes on additional debt of $40 million.

Answer #1

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A firm is considering recapitalization, and will estimate the
cost of equity with theHamada equation. The firm is able to buy
back stock at the current market price. That is, if the firm
obtains $X million in new debt, it can buy back $X million of
common stock. The current amount of debt is $60 million and rD =
8%. The current amount of equity is $200 million. The firm’s
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