A firm has the following capital structure: £100 million ofequity (market value) with 100 million shares outstanding, and £100million of debt. The beta of the firmâs stock is 1.6. The firmâscost of equity is 10 percent, and the yield on riskless bonds is 2percent. There is no tax. Assuming that the firm can borrow at therisk-free rate and that both CAPM (Capital Asset Pricing Model) andthe Modigliani-Miller theorem hold, answer the following questions.i) What is the share price of the firm? ii) What is the WACC of thefirm? iii) What should be the expected return on the marketportfolio? iv) Suppose the firm changes its capital structure sothat its debt increases to £140 million, and the equity decreasesby £60 million. What should be the firmâs cost of equity after thechange?
A firm has the following capital structure: £100 million ofequity (market value) with 100 million shares outstanding, and £100million of debt. The beta of the firmâs stock is 1.6. The firmâscost of equity is 10 percent, and the yield on riskless bonds is 2percent. There is no tax. Assuming that the firm can borrow at therisk-free rate and that both CAPM (Capital Asset Pricing Model) andthe Modigliani-Miller theorem hold, answer the following questions.i) What is the share price of the firm? ii) What is the WACC of thefirm? iii) What should be the expected return on the marketportfolio? iv) Suppose the firm changes its capital structure sothat its debt increases to £140 million, and the equity decreasesby £60 million. What should be the firmâs cost of equity after thechange?
Related questions
Which of the following statements regarding Modigliani and Miller (MM)âs propositions is most accurate?
| A. | Firm value is maximized with a capital structure consisting of 100% equity |
| B. | The required rate of return of equity increases as the firm increases its financial leverage |
| C. | The use of debt financing increases the firmâs earnings volatility |
| D. | It does not matter which capital structure firm choose because capital structure is irrelevant in terms of firm value, with or without taxes. |
| E. | All of above are wrong |
