Spam Corp. is financed entirely by common stock and has a beta of 1.0. The firm is expected to generate a level, perpectual steam of earnings and dividends. The stock has a price-earnings ratio of 8 and a cost of equity of 12.5%. The company’s stock is selling for $50. Now the firm decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free, with a 5% interest rate. The company is exempt from income taxes. Assuming MM are correct, calculate the following items after refinancing: (i) Return on equity; (ii) the stock’s beta.

Spam Corp. is financed entirely by common stock and has a beta of 1.0. The firm is expected to generate a level, perpectual steam of earnings and dividends. The stock has a price-earnings ratio of 8 and a cost of equity of 12.5%. The company’s stock is selling for $50. Now the firm decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free, with a 5% interest rate. The company is exempt from income taxes. Assuming MM are correct, calculate the following items after refinancing: (i) Return on equity; (ii) the stock’s beta.

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter15: Capital Structure Decisions

Section: Chapter Questions

Problem 11P: The Rivoli Company has no debt outstanding, and its financial position is given by the following...

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