Old Exam Questions - Capital Structure and Leverage Page 11 of 31 Pages The company is considering issuing $2.6 million worth of bonds (at par) and using the proceeds for a stock repurchase. The firm’s cost of this debt (their annual coupon rate) would be 4 percent. The risk-free rate in the economy is 3 percent, and the market risk premium is 5 percent. The company’s beta is currently 0.90, but its investment bankers estimate that the company’s beta would rise to 1.00 if it proceeds with the recapitalization. Assume that the market does not anticipate an increase in value when the firm announces that it will recapitalize, so that the firm is able to repurchase all shares at the current price per share. Determine by how much the price per share will eventually increase; that is, after the recapitalization is completed and the market does realize that additional value has been created. A.
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.