Question

Quantitative Problem: Currently, Meyers Manufacturing Enterprises (MME) has a capital structure consisting of 35% debt and 65% equity. MME's debt currently has a 7.3% yield to maturity. The risk-free rate (r_RF) is 5.3%, and the market risk premium (r_M – r_RF) is 6.3%. Using the CAPM, MME estimates that its cost of equity is currently 11.3%. The company has a 40% tax rate.

a. What is MME's current WACC? Do not round intermediate calculations. Round your answer to two decimal places.
  %

b. What is the current beta on MME's common stock? Do not round intermediate calculations. Round your answer to four decimal places.

c. What would MME's beta be if the company had no debt in its capital structure? (That is, what is MME's unlevered beta, b_U?) Do not round intermediate calculations. Round your answer to four decimal places.

MME's financial staff is considering changing its capital structure to 45% debt and 55% equity. If the company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to 7.8%. The proposed change will have no effect on the company's tax rate.

d. What would be the company's new cost of equity if it adopted the proposed change in capital structure? Do not round intermediate calculations. Round your answer to two decimal places.

e. What would be the company's new WACC if it adopted the proposed change in capital structure? Do not round intermediate calculations. Round your answer to two decimal places.

Based on your answer to Part e, would you advise MME to adopt the proposed change in capital structure? The firm should proceed with the recapitalization. The firm should Not proceed with the recapitalization.

Answer 1

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projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins Formulas - 2x 11 A = = = V General A A Wrap Text Merge Merge & Center Center Σ AutoSum : A Fill 2 Sort & SF 4:0 .00 8.9 Insert Delete Format $ - % % Number Conditional Format Formatting as Table Styles Cell Styles 2 Clear Filter Editing Find & Select Alignment Cells E K EL EM EO EPEQER ES kd = EN 7.30% 11.30% ke = WACC = File Home Insert Page Layout % Cut Calibri Ea Copy Paste Format Painter B I U - D Clipboard Font EK179 - fix EH EL EJ 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190 191 192 193 We*ke+Wd*kd(1-t) (65%)*(11.30%)+(35%)*(7.3%)*(1-0.4) 8.88% WACC = RISK PREMIUM risk free rate 6.30% 5.30% Ke = Rf + beta (Rm-Rf) 11.30% = 5.3% + beta*(6.3%) 6%= beta6.3%) beta = 0.9524 b unlevered beta = levered beta /(1+(D/E)(1-t)) unlevered beta = 0.9524/(1+(35/65)(1-0.4)) unlevered beta = 0.7198 194 H E NPV RELEVANT BETA LEVERED REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT LEASE STRAIGHT LINE GOLF IRR MACRS AC MACRS ferences BASE CASE SENSITIVITY I BOI 130% Red 0 + 2. 9 * * O ENG 25-11-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins File Home Insert Page Layout Formulas - 2x % Cut Dr Σ AutoSum : A Fill 2 Sort & SF Wrap Text General Merge Merge & Center Center $ - % % CD Number 4:0 .00 8.9 Insert Delete Format Cell Styles Calibri E Copy Paste Format Painter B I Clipboard EN194 - 2 EH EL Conditional Format Formatting as Table Styles 2 Clear -11AA = = = U - D A Font for EJ E K Find & Select Filter Editing Alignment Cells EL EM EN EO ED EQ ERE S 194 195 196 197 198 releveraging beta levered beta = unlevered beta *(1 + (D/E)(1-t)) levered beta = 0.7198*(1 +(45/55)(1-0.4)) levered beta = 1.0732 199 200 201 202 beta 1.0732 RISK PREMIUM 6.30% risk free rate 5.30% COST OF EQUITY = ke = Rf + beta (Rm-Rf) ke = 5.3% + 1.0732*(6.3%)= 12.06% 203 204 205 206 207 208 kd = 7.80% 209 210 WACC = We*ke + Wd*kd(1-t) (55%)*12.06%+(45%)*(7.8%)*(1-0.4) WACC = 8.74% THE FIRM SHOULD PROCEED WITH REAPITALIZATION yes, as WACC has decreased from 8.88% to 8.74% REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT LEASE 211 212 H E NPV RELEVANT BETA LEVERED STRAIGHT LINE GOLF IRR MACRS AC MACRS ferences BASE CASE SENSITIVITY I BOI 130% Red 0 + D E 9 * ENG 25-11-2019)