Jacinto & Jasmine Group (JJG) is considering a capital restructuring to allow $500 million in debt. Currently,  JJG is an all-equity firm with earnings before interest and taxes of $380 million. Assume unlevered firms in the same industry have betas of 0.90. Assume the market risk premium is 7% and the risk-free interest rate is 5%. Assume that the corporate tax rate is 35%. You may assume that all earnings are paid out as dividends, and that the debt is used to buy back stock. For simplicity, assume that cash flows are perpetual and the debt is perpetual.

1. How would the proposed restructuring change the value of JJG as a whole? (Hint: You may not need to compute the new cost of capital to find the new firm value.)

2. If JJG was considering issuing $2 billion in debt instead of $500 million, would the methodology you used in the previous question be equally appropriate? Why or why not?

Answer rating: 100% (QA)

a Value of Firm FCFCost of Equity Using CAPM Cost of Equity 5 09 x 7 ... View the full answer