Safety Co. has a beta of 2.84, is financed with 10% debt and has a total firm
Question:
Safety Co. has a beta of 2.84, is financed with 10% debt and has a total firm value of $10 billion. Safety’s CFO wants to raise $2 billion of debt and buy back $2 billion of equity. This debt will be perpetual and have yield of 3%. The expected return on the market is 13% and the risk free rate is 3%. Safety has a 35% tax rate.
a. What is Safety’s value after the swap, and how much of that value will be equity?
b. Using the beta-adjustment approach calculate the return that McSafey’s stockholders expect to earn after the swap.
c. Use the M&M approach to calculate:
i) The required Return on Assets for the unlevered (all-equity) firm (start by using CAPM to calculate E(R) when the Beta = 2.84 and the D/E = 1/9)
ii) The required Return on equity at the new capital structure.