Fraylor & Trancis Inc. has a D/E-ratio of 25%. Its unlevered beta is 1.2. The risk-free rate of debt amounts to 5% and the equity market risk premium is 6%. Fraylor is exempt from corporate taxes. The stream of dividends is as follows (dividend in period 1 to be paid in one year from now): Period 1 2 3 to

Fraylor & Trancis Inc. has a D/E-ratio of 25%. Its unlevered beta is 1.2. The risk-free rate of debt amounts to 5% and the equity market risk premium is 6%. Fraylor is exempt from corporate taxes.

The stream of dividends is as follows (dividend in period 1 to be paid in one year from now):

Period	1	2		3 to infinity
Dividends per share	3.8	4		4.2
Annual growth rate (g)				4%

1. What is the rate of return that Fraylor's shareholders expect?
2. What is the fair price of Fraylor's stock? (Assume the cost of equity capital to be 15% if you could not come up with a solution for part a). Note that this is not the right answer for part a).  
3. What is the total firm value value of Fraylor if the corporation has 500.000 shares outstanding?
4. What would you recommend Fraylor's CFO to do if her goal is to optimize the capital structure?

Expert Answer

a) To calculate the rate of return that Fraylor's shareholders expect, we can use the Capital Asset View the full answer