Somedebt, Inc., has a little debt (w_d 5 20%) with required return 7%. It is considering restructuring to increase its percentage of debt to wd 5 40%. Its beta is 0.8, the risk-free rate is 6%, the market risk premium is 7%, and if it restructures, the required return on its debt will be 9%. Somedebt’s tax rate is 25%.
a. Using the Hamada equation, calculate Somedebt’s unlevered required return and its required return on equity after the recapitalization.
b. Using the MM model with corporate taxes (Equation 17-16), calculate Somedebt’s unlevered required return and its required return on equity after the recapitalization. You will have to use algebra to solve Equation 17-16 for r_sU or use goal seek in Excel to find r_sU.

c. Using the APV model, calculate Somedebt’s unlevered required return
and its required return on equity after the recapitalization.
d. Explain why these six answers are different.

Data from in Equation 17-16

Transcribed Image Text:

T₁ = ₁ + (rr)(1-T)(w/w) r. sl. r. sl