40. A company is estimating its optimal capital structure. Now the company has a capital structure that consists of 50% debt and 50% equity, based on market values (debt to equity D/S ratio is 1.0). The risk-free rate (rRF) is 3.5% and the market risk premium (rM – rRF) is 5%. Currently the company’s cost of equity, which is based on the CAPM, is 13.5% and its tax rate is 30%. Find the firm’s current leveraged beta using the CAPM
2.0 |
||
1.5 |
||
2.6 |
||
1.9 |
41. Based on the information from Question 40, find the firm’s unleveraged beta using the Hamada Equation
1.95 |
||
1.0 |
||
1.18 |
||
1.29 |
42. Based on the information from Question 40 and 41, what would be the company’s new leveraged beta if it were to change its capital structure to 60% debt and 40% equity (D/S=1.5) using the Hamada Equation?
1.65 |
||
1.95 |
||
2.16 |
||
2.41 |
43. Based on the information from Questions 40 ~ 42, what would be the company’s new cost of equity if it were to change its capital structure to 60% debt and 40% equity (D/S =1.5) using the CAPM?
13.8% |
||
15.6% |
||
16.8% |
||
18.5% |
Solution:
40.Calculation of firm’s current leveraged beta using the CAPM
Cost of equity=Risk free rate+Beta*Market risk premium
13.5%=3.5%+Beta*5%
Beta=10.00%/5%
=2
41.Calculation of firm’s unleveraged beta using the Hamada Equation
unleveraged beta=Leveraged beta/1+(1-tax rate)*debt/equity
=2/1+(1-0.30)*1
=1.176 or 1.18
42.Calculation of company’s new leveraged beta sing the Hamada Equation
New leveraged beta=UnLevarged beta[1+(1-tax rate)*Debt/equity]
=1.18[1+(1-0.30)*1.5]
=2.419 or 2.41
43.Calculation of company’s new cost of equity
New Cost of equity=Risk free rate+Beta*Market risk premium
=3.5%+2.41*5%
=15.55 or 15.60%
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