# ps2 - ECON 6100S Corporate Finance(Prof Fei DING Problem...

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1 ECON 6100S: Corporate Finance (Prof. Fei DING) Problem Set 2 You can work in groups of 5 people or less. Hand in one solution per group in hard copy before class on the specified due date. Late problem sets are not accepted. Problem 1. Arc Levers is financed by a mixture of debt and equity. You have the following information about its cost of capital. r E = ? r D = 12% r A = ? E = 1.5 D = ? A = ? r F = 10% r M = 18% D/V = 0.5 (a) Please fill in the blanks. (b) Suppose now that Arc repurchases debt and issues equity so that D/V = 0.3. This reduced borrowing causes r D to fall to 11%. How do the other variables change? Problem 2. Knar Co. pays no taxes and is financed entirely by common stock. The stock has a beta of 0.8 and a price-earnings ratio of 12.5 and is priced to offer an 8% expected return. Knar now decides to repurchase half the common stock and substitute an equal value of debt. If the debt yields a riskfree 5% return, calculate: (a) The beta of the common stock after the refinancing; (b)

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