Question 5: Ungearing and re-gearing the beta factors-Pure play mechanism The capital structure of Smog Inc....

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Question 5: Ungearing and re-gearing the beta factors-Pure play mechanism The capital structure of Smog Inc. consists of 8% 15 year Bonds (Semi-annual) Common stocks ($10 par) Retained earnings Total capital $30 M $20M $22M $72M Additional Information 1) The current market price of a bond is $816.67 2) Smog's common stock sells at $22.75 each 3) The market portfolio return is 11%. Interest rate on treasury bonds is 4% and beta is 1.53 4) The company wants to borrow more debt which will increase the gearing (debt to equity ratio) to 1:1 but will not affect the stock price due to increased tax shield. Tax rate is 30%. Required a) Compute the capital structure weights b) What is the current cost of equity, Ke and cost of debt, Kd(1- T)? c) Compute WACC d) Compute the firm's unlevered beta? e) What is the firm's new cost of equity with the additional borrowing? Question 5: Ungearing and re-gearing the beta factors-Pure play mechanism The capital structure of Smog Inc. consists of 8% 15 year Bonds (Semi-annual) Common stocks ($10 par) Retained earnings Total capital $30 M $20M $22M $72M Additional Information 1) The current market price of a bond is $816.67 2) Smog's common stock sells at $22.75 each 3) The market portfolio return is 11%. Interest rate on treasury bonds is 4% and beta is 1.53 4) The company wants to borrow more debt which will increase the gearing (debt to equity ratio) to 1:1 but will not affect the stock price due to increased tax shield. Tax rate is 30%. Required a) Compute the capital structure weights b) What is the current cost of equity, Ke and cost of debt, Kd(1- T)? c) Compute WACC d) Compute the firm's unlevered beta? e) What is the firm's new cost of equity with the additional borrowing?