Question

1. Holding Motors has $20 million on assets, which were financed with $6 million of debt and $14 million in equity. Holding's beta is currently 1.4, and its tax rate is 30%. Using the Hamada equation, what is Holdings unlevered beta?

a. 1.08

b. 0.93

c. 1.24

d. 0.78

2. Hurricane Software is trying to establish its optimal capital structure. Its current capital structure consists of 20% debt and 80% equity; however, the CEO believes that the firm should us more debt. The risk-free rate is 2%, the expected return on the market is 12% and the firms tax rate is 60%. Currently, Hurricane's cost of equity is 13%. What would be Hurricane's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity?

a. 12%

b. 14%

c. 18%

d. 16%

Thank you in advance!!

Answer 1

1. Correct choice - a. 1.08

Unlevered Beta Total Debt Total Equity Beta Tax rate 2 3 4 5 6 14 1.40 | 30.0% 1.08

Tax rate Unlevered Beta Beta Total Debt Total Equity 0.3 D3/(1+(1-E3) B3/C3) 14 1.4 6 3

2. Correct choice - d. 16%

2% 12% 10% 1390 2 Risk free rate Market return Market risk premium Cost of equity 5 6 Using CAPM, Beta 1.10 9 10 Levered Beta 1.10 Unlevered Beta Total Debt Total Equity Beta Tax rate 12 13 14 15 16 17 18 19 20 21 20.0% 80. 0% 1.10 60.0% 1.00 Debt % Equity % Tax rate Unlevered beta Levered beta 50.0% 50.0% 60.0% 1.00 1.40 Risk free rate Market return Market risk premium Beta 2% 12% 10% 1.40 23 24 25 26 27 28 29 Using CAPM, Cost of Equity 16%