Question

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 (r_RF) is 6% 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 12% and its tax rate is 40%. Find the firm’s current leveraged beta using the CAPM

		1.0
		1.2
		1.4
		1.6

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

		1.0
		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?

		1.0
		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 1

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