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Ratzina corporation is operating at a 75% debt level. The company has a target capital structure...

Ratzina corporation is operating at a 75% debt level. The company has a target capital structure of 60% debt and 40%equity. The market value of the equity is $ 50 million and that of debt is $ 60 million. Currently the book and market value of the debt is equal. The cost of equity of the company is 16% and the cost of debt is 10%. Ignore taxation and assume that the company is a zero growth firm which fully pays out its earnings as dividends.

If the company redeem a portion of its debt to meet the target capital structure, and as a consequence cost of equity goes down to 12, what would be the new value of the company?

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Answer #1

Cost of equity = dividend / price

        16%      = dividend/ $50 Million

Dividend = $ 8 million

full payout is equal to earning so, dividend= earning = $ 8 million

New value of firm=

cost of equity = dividend/ price

      12%      = $ 8 million/ price

Market value = $ 66.66 million

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