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

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