Question

Globex Corp. currently has a capital structure consisting of 30% debt and 70% equity. However, Globex Corp.’s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3.5%, the market risk premium is 8%, and Globex Corp.’s beta is 1.25. If the firm’s tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same?

Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 10%, and its tax rate is 25%. It currently has a levered beta of 1.25. The risk-free rate is 3.5%, and the risk premium on the market is 8%. US Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm’s level of debt will cause its before-tax cost of debt to increase to 12%.

First, solve for US Robotics Inc.’s unlevered beta.

Use US Robotics Inc.’s unlevered beta to solve for the firm’s levered beta with the new capital structure.

Use US Robotics Inc.’s levered beta under the new capital structure, to solve for its cost of equity under the new capital structure.

What will the firm’s weighted average cost of capital (WACC) be if it makes this change in its capital structure?

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

I HAVE DONE SUM EARLIER AND ROUNDING CONDITIONS MENTIONED, BUT NOT IN THIS SUM, SO ROUNDED TO 2 DECIMALS. INTERMEDIATE ROUNDING IS NOT DONE

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins Formulas - 2x 11 pt General AA = = = A Wrap Text Merge Merge & Center Center SF $ - % % 4:0 .00 8.9 Insert Delete Format Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Alignment Number Cells File Home Insert Page Layout * Cut Calibri E Copy Paste Format Painter B I U - D Clipboard Font 5495 C _ J K L 489 490 P Q R S M L GLOBEX unlevered beta = levered beta /(1+(D/E)(1-t)) unlevered beta = 1.25/(1+(30/70)(1-0.25)) unlevered beta = 0.95 491 ANS 1 492 493 494 US ROBOTICS unlevered beta = levered beta /(1+(D/E)(1-t)) unlevered beta = 1.25/(1+(30/70)(1-0.25)) unlevered beta = 0.95 ANS 2 495 496 497 498 499 500 501 502 503 504 505 506 507 NON Rea releveraging beta levered beta = unlevered beta * (1 + (D/E)(1-t)) levered beta = 0.95*(1 + (60/40)(1-0.25)) levered beta = ANS 3 2.01 beta RISK PREMIUM risk free rate invest, EAA MI-np-ir_ REPLACEMENT S 2.01 8.00% 3.50% EAC MACRS RATION PBP ARR HPR GMAM NPV RELEVANT BETA LEVERED IRRnpvbeta ferences REPLACEMENT BOND OPTION TO WAITSTEIN III BOU 130% O B A .lll 21-11-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins Formulas - 2x 11 pt General AA = = = A Wrap Text Merge Merge & Center Center SF $ - % % 4:0 .00 8.9 Insert Delete Format File Home Insert Page Layout % Cut Calibri E Copy Paste Format Painter B I U - D Clipboard Font S499 Fax J K L Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Alignment Number Cells M O P Q R S 499 500 501 releveraging beta levered beta = unlevered beta *(1 + (D/E)(1-t)) levered beta = 0.95*(1 + (60/40)(1-0.25)) levered beta = 2.01 502 503 ANS 3 504 505 506 beta RISK PREMIUM risk free rate 2.01 8.00% 3.50% 507 508 509 510 Ke = Rf + beta (Rm-Rf) Ke = 3.5% +2.01*(8%)= ANS 4 19.58% 511 kd = 12% 512 513 514 515 WACC = We*ke + Wd*kd(1-t) (40/100)*19.58%+(60/100)*(12%)*(1-0.25) WACC = 13.23% ANS 5 516 517 H RATION PBP ARR invest, EAA MI-np-ir_ REPLACEMENT S HPR GMAM EAC MACRS NPV RELEVANT BETA LEVERED REPLACEMENT BOND I RRnpvbeta 1 ferences OPTION TO WAIT BOU 130% STEIN III 0 Rea . B 9 . * ENG 21-11-2019