Capital Structure and Leverage 24

Capital Structure and Leverage 24 - C D E 41 Your company...

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Old Exam Questions - Capital Structure and Leverage Page 24 of 31 Pages C. $76.43 D. $83.08 E. $78.81 41. Your company pays all of its after-tax earnings out in the form of dividends and currently has $0 of debt. Its EBIT is $6,000,000, its tax rate is 35 percent, its current cost of equity is 13 percent, and it has 600,000 shares outstanding. As you can calculate, its current price is $50.00 per share. Your company can borrow $6,000,000 of new perpetual debt at a before-tax cost of debt of 4 percent. The increased financial leverage will result in the cost of equity going up to 14 percent. Determine the new price of the stock after a true equilibrium is eventually established, if the firm is able to use the proceeds of the debt issue to buy back $6,000,000 of stock, but investors do not anticipate an increase in value (from the increased leverage) and the firm is able to repurchase stock at the current price. A.
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