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Unformatted text preview: PizzaPalace. h. (1) For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC. Answer: MM theory implies that beta changes with leverage. b u is the beta of a firm when it has no debt (the unlevered beta.) Hamadas equation provides the beta of a levered firm: B L = B U [1 + (1  T)(D/S)]. For example, to find the cost of equity for w d = 20%, we first use Hamadas equation to find beta: b = b U [1 + (1  T)(D/S)] = 1.0 [1 + (10.4) (20% / 80%)] = 1.15 Then use CAPM to find the cost of equity: r s = r RF + b (RP M ) = 6% + 1.15 (6%) = 12.9% We can repeat this for the capital structures under consideration. w d D/S b r s 0% 0.00 1.000 12.00% 20% 0.25 1.150 12.90% 30% 0.43 1.257 13.54% 40% 0.67 1.400 14.40% 50% 1.00 1.600 15.60%...
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 Spring '08
 Staff
 Debt, Leverage

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