Question

# 31. SA company is trying to estimate its optimal capital structure. Right now, it has a...

31. SA company is trying to estimate its optimal capital structure. Right now, it has a capital structure that consists of 20% debt and 80% equity, based on market values (its debt to equity D/S ratio is 0.25). The risk-free rate (rRF) is 6% and the market risk premium (rM – rRF) is 5%. Currently the company’s cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. Find the firm’s current leveraged beta using the CAPM

 1 1.2 1.4 1.6

32. Based on the information from Question 31, find the firm’s unleveraged beta using the Hamada Equation

 1 1.04 1.08 1.2

33. Based on the information from Question 31 and 32, what would be Simon’s new leveraged beta if it were to change its capital structure to 50% debt and 50% equity using the Hamada Equation?

 1 1.04 1.2 1.67

34. Based on the information from Question 31 ~ 33, what would be Simon’s new cost of equity if it were to change its capital structure to 50% debt and 50% equity using the CAPM?

 12.8% 13.6% 14.3% 15.8%

Answer : 31) Correct option is 1.2

Reason :

Cost of Equity = Risk Free Rate + [Beta * Market Risk Premium]

12% = 6% + Beta * 5%

=> Beta = (12 - 6 ) / 5

= 1.2

Answer : 32 ) Correct option is 1.04

Beta Levered = Beta Unlevered * [1 + (1 - Tax rate) * Debt Equity Ratio]

==> Beta Unleverd = Beta Levered / [1 + (1 - Tax rate) * Debt Equity Ratio]

= 1.2 / [1 + (1 - 0.40) * 0.25]

= 1.2 / 1.15

= 1.04347826086 or 1.04

Answer : 33) Correct Option is 1.67

Beta Levered = Beta Unlevered * [1 + (1 - Tax rate) * Debt Equity Ratio]

= 1.04347826086* [1 + (1 - 0.40) * 1]

= 1.66956521737 or 1.67

Answer : 34) Correct Option is 14.3

Cost of equity = Risk Free Rate + [Beta * Market Risk Premium]

= 6% + [1.66956521737 * 5%]

= 14.3

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