Question

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 (r_{RF}) is 3.5% and the market
risk premium (r_{M} – r_{RF}) 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% |

Answer #1

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%**

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...

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