Rauch Inc.’s current stock price is $2 per share and it has 300 million shares outstanding. The book value of its equity is $200 million and the book value of its debt is $400 million. Assume that the beta of the firm’s debt is 0.5 and the beta of the firm’s equity is 1.5. The risk-free rate is 3% and the expected return on the market is 9%. Assume that there are no taxes or other market imperfections. What is Rauch’s asset beta? What is Rauch’s asset cost of capital? Assume that Rauch Inc. issues an additional $100 million in debt and uses the proceeds to buy back its equity. What is Rauch’s asset beta after recapitalization? What is Rauch’s asset cost of capital after recapitalization? After the recapitalization described in part (b), Rauch’s debt beta is now 0.6. What is Rauch’s equity beta after recapitalization? What is Rauch’s cost of equity after recapitalization? From the standpoint of Rauch Inc. (i.e., the firm as a whole), what is the net present value(NPV) of the above-mentioned recapitalization?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Rauch Inc.’s current stock price is $2 per share and it has 300 million shares outstanding. The book value of its equity is $200 million and the book value of its debt is $400 million. Assume that the beta of the firm’s debt is 0.5 and the beta of the firm’s equity is 1.5. The risk-free rate is 3% and the expected return on the market is 9%. Assume that there are no taxes or other market imperfections.
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What is Rauch’s asset beta? What is Rauch’s asset cost of capital?
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Assume that Rauch Inc. issues an additional $100 million in debt and uses the proceeds to buy back its equity. What is Rauch’s asset beta after recapitalization? What is Rauch’s asset cost of capital after recapitalization?
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After the recapitalization described in part (b), Rauch’s debt beta is now 0.6. What is Rauch’s equity beta after recapitalization? What is Rauch’s
cost of equity after recapitalization? -
From the standpoint of Rauch Inc. (i.e., the firm as a whole), what is the
net present value (NPV) of the above-mentioned recapitalization?
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