You have the following data on Joe's Corporation: EBIT:$1,000,000 Tax rate:40% Cost of equity:10% Joe's is a

Question:

You have the following data on Joe's Corporation:

EBIT:$1,000,000

Tax rate:40%

Cost of equity:10%

Joe's is a zero growth firm, and is currently financed entirely with equity (in other words, it currently has no debt).

One of the corporate officers has suggested that since interest rates are so low, Joe might be better off if he borrowed some money and used it to buy back stock, thereby making use of debt financing in the firm. He presents the following data in his analysis:

Amount of debt proposed: $1,000,000

Interest rate:6%

New cost of equity after the money after the money is borrowed: 12%

Joe has come to you for advice. Prepare an analysis for him that indicates whether or not the proposal should be accepted.

Cost Of Equity
The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the...