Question

Spam Corp. is financed entirely by common stock and has a beta of 1.65. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price-earnings ratio of 7.50 and a cost of equity of 13.33%. The company's stock is selling for $26. Now the firm decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free, with an interest rate of 6.5%. The company is exempt from corporate income taxes. Assume MM are correct. a. Calculate the cost of equity after the refinancing. (Enter your answer as a percent rounded to 2 decimal places.) b. Calculate the overall cost of capital (WACC) after the refinancing. (Enter your answer as a percent rounded to 2 decimal places.) c. Calculate the price-earnings ratio after the refinancing. (Do not round intermediate calculations. Round your answer to 2 decimal places.) d. Calculate the stock price after the refinancing. e. Calculate the stock's beta after the refinancing. (Round your answer to 1 decimal place.) a. Cost of equity b. Cost of capital c. Price-earnings ratio d. Stock price e. Stock's beta

Answer 1

The answer is a) ke=20.16% b) ko=13.33% c) p/e ratio = 4.96 times d) stock price = $ 26 e) stock beta = 2 .
acost quiy (Ke) pam p afie efirnth Accevchng to m&n arprecch Ke = Ko t Debt Lquity Ko- 13.35/ becuse ts stafni that eirn & finaned enRYCly by common stock no after YePurchase wc have so ocbt &S0 eaty Ke after reenancdng 13.35/t50 (13-83- 66) I's Ke 20 167 WACC after cfincandng same as befe 13-33/ because M&Mappro Cach cissumes that thely Cxist pespect capifal markets so the capital structure and wosth af Firm witt not change proof Kdxwd t Ke xwe Ko = 13 33/ 6.5 XS01+201% x 50 PE TaHo after repfnancing MPS/EP PE Yatio Ict us assume Spam Corp has share lOD market vtue of equlty apter sepurchase half of shares we have 1300 & Equity &1300 debt Prevaus Eps 26/150 - $ 100 x 26 2600 3.467

C Net Income 3461 8H67 X 100 Inerest on diot e 6-57. o0 130 ICSS Canings availiable to sharehaldes 262.2 NO Of shares afkr repuichose 50 NEO EPS 5.24 mKt Price= 26 (5-244 /26y 100 VKe inew) So 20-16 .. PE Tato 4.96 1/20-16 a) stock price afer refincndng = PE TAHO X EPS MPS 4.96 X5.24 - 26.010 stock beta after refinancine ke-kd) StoCK beta WACC-Kd (20.16-6.5)1 13.66 6.5) (13-33 6.83