Company P is a regional pizza restaurant chain. The given details are as follows, EBIT is $50 million, Tax rate is 40%, Risk-free rate of return is 6%, Market risk premium is 6%, Outstanding shares 10 million. As of now company is financed with equity only, there is no debt. Now, the company wanted to raise capital by using some debt. When the company were to recapitalize, then debt would be issued, and funds received would be used as repurchase stock. To calculate: ROE for both the firms.

Question

A. CALCULATE the cost of equity capital of H Ltd., whose risk-free rate of return equals 10%. The firm's beta equals 1.75 and the return on the market portfolio equals to 15%. B. The current ratio of H Ltd is 5:1 and standard current ratio given by accounting bodies is 2:1? Do you think that H Ltd should try to reduce its current ratio?

Answer 1

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Chapter 16, Problem 5MC

Summary Introduction

Case summary:

Company P is a regional pizza restaurant chain. The given details are as follows,

EBIT is $50 million,

Tax rate is 40%,

Risk-free rate of return is 6%,

Market risk premium is 6%,

Outstanding shares 10 million.

As of now company is financed with equity only, there is no debt. Now, the company wanted to raise capital by using some debt. When the company were to recapitalize, then debt would be issued, and funds received would be used as repurchase stock.

To calculate: ROE for both the firms.

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