Optimal Capital Structure with HamadaBeckman Engineering and Associates (BEA) is considering a change in itscapital structure. BEA currently has $20 million in debt carrying a rate of8%, and its stock price is $40 per share with 2 million shares outstanding.BEA is a zero-growth firm and pays out all of its earnings as dividends.The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-statetax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEAis considering increasing its debt level to a capital structure with 40% debt,based on market values, and repurchasing shares with the extra money thatit borrows. BEA will have to retire the old debt in order to issue new debt,and the rate on the new debt will be 9%. BEA has a beta of 1.0.a. What is BEA’s unlevered beta? Use market value D/S (which is the sameas wd/ws) when unlevering.b. What are BEA’s new beta and cost of equity if it has 40% debt?c. What are BEA’s WACC and total value of the firm with 40% debt?
Optimal Capital Structure with Hamada
Beckman Engineering and Associates (BEA) is considering a change in its
capital structure. BEA currently has $20 million in debt carrying a rate of
8%, and its stock price is $40 per share with 2 million shares outstanding.
BEA is a zero-growth firm and pays out all of its earnings as dividends.
The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-state
tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA
is considering increasing its debt level to a capital structure with 40% debt,
based on market values, and repurchasing shares with the extra money that
it borrows. BEA will have to retire the old debt in order to issue new debt,
and the rate on the new debt will be 9%. BEA has a beta of 1.0.
a. What is BEA’s unlevered beta? Use market value D/S (which is the same
as wd
/ws
) when unlevering.
b. What are BEA’s new beta and
c. What are BEA’s WACC and total value of the firm with 40% debt?
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