Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20

Question:

Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8 percent, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. EBIT is $14.933 million, and BEA faces a 40 percent federal-plus-state tax rate. The market risk premium is 4 percent, and the risk free rate is 6 percent. BEA is considering increasing its debt level to a capital structure with 40 percent debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9 percent.

BEA has a beta of 1.0.

a. What is BEA’s unleveled beta? Use market value D/S when unlevering.

b. What are BEA’s new beta and cost of equity if it has 40 percent debt?

c. What are BEA’s WACC and total value of the firm with 40 percent 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
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