Question

Excel Online Structured Activity: Recapitalization Currently, Forever Flowers Inc. has a capital structure consisting of 30% debt and 70% equity. Forever's debt currently has an 8% yield to maturity. The risk-free rate (TRF) is 3%, and the market risk premium ( PRPis 7%. Using the CAPM, Forever estimates that its cost of equity is currently 12%. The company has a 40% tax rate. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Open spreadsheet a. What is Forever's current WACC? Round your answer to two decimal places. b. What is the current beta on Forever's common stock? Round your answer to two decimal places. c. What would Forever's beta be if the company had no debt in its capital structure? (That is, what is Forever's unlevered beta, bu?) Round your answer to two decimal places. Next Rack

please help me to solve for the correct answers. thank you

Answer 1

a) Compute F's current WACC as follows: WACC(in ) w,x R.) WACC(in %) (0.70x12)+0.30 x 8(1 40%) Wx R (1-Tax rate) = WACC(in ) 8.4 (0.30x8x0.60) WACC(in %) 8.4 + 1.44 WACC(in %)9.84% where We Weight of the firm's equity 70% Wd - Weight of the firm's debt 30% Re - cost of equity 12 % Rd cost of debt 8% = T Tax rate = 40%

b) Compute current equity Beta as follows: Using Capital Asset Pricing Model Required Rate of Return Rf b (Rm - Rf Where, Rf- Risk free return 3% b Beta ? Rm Expected return on market portfolio Rm-Rf- Market risk premium 7% Required rate of return R, +b(R-R,) 12% 3%b(7%) 12%-3% b= 7% b 1.29 c) Calculation of unlevered Beta (Asset beta) Unlevered Beta Equity Beta / [(1+(1-tax rate) x(debt/equity) -1.29 [1+ (1-0.4) x (0.3+0.7)] - 1.29 [1+(0.6x0.42857)] - 1.29 [1+(0.6x0.42857)] = 1.29 [1+0.257] = 1.29 1.257 Unlevered Beta = 1.03

d) Calculation of cost of equity Calculation of levered beta at 40% debt Levered Beta = Unlevered Beta x [(1+(1-tax rate) (debt/equity) - 1.03x [1+ (1-0.4) x (0.4+0.6)] 1.03 x [1+(0.6x0.667)] 1.03 x [1+(0.6x0.667)] = 1.03 x [1+0.4] = 1.03 x1.4 Levered Beta 1.44 - Calculation of cost of equity Cost of Equity Ke Rf+ b (Rm - Rf) WwwW = 3 1.44x7 = 3 10.08 = 13.08%

e) Compute new WACC as follows: WACC(in %) (w,x R.)+ W x R (1-Tax rate WACC(in %)(0.60 x13.08)0.40x 9.5 (1-40%) WACC(in % 7.848+(0.40 x9.5x0.60) WACC(in%)= 7.848+2.28 WACC(in %) 10.13% where We - Weight of the firm's equity 60% Wd - Weight of the firm's debt = 40% Re cost of equity 13.08 % Rd cost of debt 9.5% T Tax rate 40% No, it should not adopt the proposed change in capital structure because the wacc is increasing from 9.84% to 10.13%