CHAPTER 17

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Unformatted text preview: nd the firm’s cost of capital is 8%. We know that these overall firm values will not change after the refinancing and that the debt is risk­free. a. 0.8 = (0.5 ´ 0) + (0.5 ´ bE) bE = 1.60 b. Before the refinancing, the stock’s required return is 8% and the risk­free rate is 5%; thus, the risk premium for the stock is 3%. c. After the refinancing: 0.08 = (0.5 ´ 0.05) + (0.5 ´ rE) rE = 0.11 = 11.0% After the refinancing, the risk premium for the stock is 6%. d. The required return for the debt is 5%, the risk­free rate. e. The required return for the company remains at 8%. f. Let E be the operating profit of the company and N the number of shares outstanding before the refinancing. Also, we know that E is (0.08V). Thus, the earnings per share before the refinancing is: EPSB = 0.08V/N After the refinancing the operating profit is still E and the number of shares is (0.5 ´ N). Interest on the debt is 5% of the value of the debt, which is (0.5 ´ V). Thus, the earnings per share after...
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This note was uploaded on 04/26/2013 for the course MATH 289Q taught by Professor Jamesbridgeman during the Fall '04 term at UConn.

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