Safeco Inc. is a manufacturing company that has grown substantially since it was formed. Safeco Inc.'s capital
Question:
Safeco Inc. is a manufacturing company that has grown substantially since it was formed. Safeco Inc.'s capital structure consists of 10 percent debt and 90 percent equity, and the beta on its common stock is 1.2. Safeco can borrow at the long-term government rate of 15 percent, and pays taxes of 45 percent.The expected return on the market is 20 percent. The new management believes that Safeco Inc.'s capital structure is too conservative and they suggest a capital structure of 50 percent equity and 50 percent debt.Assume any new shares can be sold at the market price.
Required:
a)What would Safeco Inc.'s beta and cost of equity be after the proposed changes?
b)What is Safeco's weighted average cost of capital before and after the proposed changes?