Optimal Capital Structure with Hamada

Roberts Engineering and Associates (REA) is considering a change in its capital structure.

--REA currently has the percent debt and cost of debt listed to the right.

--Its current stock price and shares outstanding are listed to the right.

--REA is a zero-growth firm and pays out all of its earnings as dividends.

--The firm's EBIT and tax rate are listed to the right.

--The market risk premium and risk-free rate are listed to the right.

--REA is considering increasing its debt level to a capital structure with the new weight of debt listed to the right.

--It will repurchase shares with the extra money that it borrows.

--REA will have to retire the old debt in order issue new debt and the rate on the new debt will be the amount listed on the right.

--REA has a beta listed right.

a. What is REA's unlevered beta? Use the market value D/S (which is the same as wD/wS when unlevering). (5 points)

b. What are REA's new beta and cost of equity if it has the new weight of debt on the right? (10 points)

c. Calculate the new after-tax cost of debt. (5 points)

d. What is BEA's WACC with the new weight of debt? (5 points)

e. What is the total value of the firm? (5 points)

wD = weight of current debt	30%
rD = current cost of debt	12.5%
REA stock price	$ 42.00
REA shares outstanding	1,899,000.00
REA EBIT	14,933,000.00
T = tax rate	41%
rM-rRF=Market risk premium	12.00%
rRF = risk-free rate	12.00%
rND = cost of new debt	13.00%
wND = weight of new debt	30%	for part b only
b = beta	1.60