MM Corp. has 50,000 shares outstanding with share price of $18. It has
debt with market value of $300,000. The equity beta is 1.2 and debt beta is 0.1. The risk-free
rate is 2% and the market risk premium is 6%. There are no corporate taxes. The firm
makes a surprise announcement to issue additional shares for $100,000 and use the proceeds
to buy back debt. Assume that the risk and the market value of the debt are unaffected by
the announcement. What will be the new cost of equity after the recapitalization? Does it
increase, decrease, or remain unchanged after recapitalization? Why?

Answer rating: 100% (QA)

First let us compute Modigliani Millers twofactor model equation without considering the recapitalization Cost of Equity CoE RiskFree Rate Beta Market ... View the full answer