Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital
Question:
Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value. Right now, Cartwright has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6% and the market risk premium, rM-rRF is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Cartwright's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?
Hint: Do the following 4 steps.
Step 1: Find the firm's current levered beta using the CAPM.
Step 2: Find the firm's unlevered beta using the Hamada equation.
Step 3: Find the new levered beta given the new capital structure using the Hamada equation.
Step 4: Find the firms new cost of equity given its new beta and the CAPM:.
13.00% | ||
13.64% | ||
14.35% | ||
14.72% | ||
15.60% |
Federal Taxation 2016 Comprehensive
ISBN: 9780134104379
29th edition
Authors: Thomas R. Pope, Timothy J. Rupert, Kenneth E. Anderson