Flex Logic System (FLS) is considering a change in its capital structure. FLS currently has $20 million

Question:

Flex Logic System (FLS) is considering a change in its capital structure. FLS currently has $20 million in debt carrying a rate of 8%, and its stock price is $20 per share with 4 million shares outstanding. FLS is a zero-growth firm and pays out all of its earnings as dividends.

EBIT is $15.262 million, and FLS has a 30% tax rate. The market risk premium is 4%, and the risk-free rate is 5%. FLS is considering increasing its debt level to a capital structure with 50% debt, based on market values, and repurchasing shares with the extra money that it borrows. FLS will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9.5%. FLS has a beta of 1.2.

a. What is FLS's unlevered beta? Use market value D/S when unlevering.

b. What are FLS's new beta and cost of equity if it has 50% debt?

c. What are FLS's WACC and total value of the firm with 50% debt?

Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a... Cost Of Equity
The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the...

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