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...
View Full Document