# Question

ABC Company, an unleveraged firm, has a total market value of $10 million, consisting of 500,000 shares of common stock selling at $20/share. Management is considering recapitalizing by issuing enough debt so that the firm as a capital structure consisting of 20% debt at a before tax cost of 10%. ABC will use the proceeds to repurchase the stock at the new equilibrium market price. ABC’s marginal tax rate is 40%. It has EBIT of $2 million, it expects zero growth in EBIT and pays out all earnings as dividends.

a) Assume ABC’s levered beta is 1.15, the risk free rate (Rf) is 7% and the expected market return (Rm) is 12%. What is the new cost of equity under the capital structure financed with 20% debt?

b) Using the new cost of equity, what is the new WACC?

c) What is the new total corporate value of ABC?

a) Assume ABC’s levered beta is 1.15, the risk free rate (Rf) is 7% and the expected market return (Rm) is 12%. What is the new cost of equity under the capital structure financed with 20% debt?

b) Using the new cost of equity, what is the new WACC?

c) What is the new total corporate value of ABC?

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