Question

Problem 15-10
Optimal Capital Structure with Hamada

Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. The firm's EBIT is $12.168 million, and it faces a 30% federal-plus-state tax rate. The market risk premium is 5%, and the risk-free rate is 7%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 11%. BEA has a beta of 1.1.

1. What is BEA's unlevered beta before restructuring? Use market value D/S (which is the same as w_d/w_s) when unlevering. Round your answer to two decimal places.
   
   
2. What are BEA's new beta after releveraging and cost of equity if it has 40% debt? Round your answers to two decimal places.

   Beta
   Cost of equity	%

   
   
3. What is BEA's WACC after releveraging? Round your answer to two decimal places.
   %
   
   What is the total value of the firm with 40 % debt? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
   $   million

Answer 1

(9) in un levered E Bu = Bex AL D(1-t) +E the given Question BL = 11 E = 2x40 = 80 million D = 20 million t = 30% 0.8 So Bu=1.18 - 0.2 (1-0.3) +0.8 = 1.14 0.8 0.94 = 0.94 (rounded off to two decimal places) 1 (6) levered B PL = Bux D(1-t) +E

situation debt in to this you now here portion raises So E = 0.6 D = 0.4 So B = 0.94 x 0.4(1-0.3) +0.6 - 1.38 I 0.6 1.38 Cost of Equity ke= Rf + B (Rm - Rf) where Rf = Risk free rate - Rm - Rf = market risk premium = 7% + 1.38 [57 so Cost of Equity = 7+ 6.9 = 13.9% - (c) weighted average Cost of capital: - WACC = Wo XV (1-t) + Wexrs Wp = weight of debit = 0.4 rd- rate of debt = 8%. WE = weight of t* Equity = 0.6 rs = return on Security (Cost of fanity) t = tax rate where,

So WACC = 0.468 (1-0.3 +0.6 x 13.9. = 2.24 + 8:34 = 10.58% firm: Total value of EBIT = $12.168 million Debt portion = you Tax= 30% value = EBIT (1-T] WACC 12.168 (-03) so 10.58% - $80.51 million