Optimal Capital Structure with Hamada Beckman Engineering and Associates (BEA) i

Question

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 6%, 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 $13.228 million, and it faces a 35% federal-plus-state tax rate. The market risk premium is 6%, and the risk-free rate is 5%. BEA is considering increasing its debt level to a capital structure with 45% 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 13%. BEA has a beta of 1.2.

B. What are BEA's new beta after releveraging and cost of equity if it has 45% debt? Round your answers to two decimal places.

C. What is BEA's WACC after releveraging? Round your answer to two decimal places.
%

What is the total value of the firm with 45 % 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

PLEASE HELP WITH B AND C

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Explanation / Answer

A. What is BEA's unlevered beta before restructuring? Use market value D/S (which is the same as wd/ws) when unlevering.

Unlevered beta = Levered Beta/(1+(1-tax rate)*D/E)

Unlevered beta = 1.2/(1+(1-0.35)*20/80)

Unlevered beta = 1.0322

Unlevered beta = 1.03 (approx)

B. What are BEA's new beta after releveraging and cost of equity if it has 45% debt? Round your answers to two decimal places.

D/E = 45%/(1-45%) = 45/55

BEA's new beta after releveraging = Unlevered Beta*(1+(1-tax rate)*D/E)

BEA's new beta after releveraging = 1.0322*(1+(1-0.35)*45/55)

BEA's new beta after releveraging = 1.58 (approx)

Cost of equity = risk-free rate + market risk premium*beta

Cost of equity = 5 + 6*1.58

Cost of equity = 14.48%

Beta 1.58
Cost of equity 14.48%

C. What is BEA's WACC after releveraging? Round your answer to two decimal places.

WACC = weight of equity*cost of equity + weight of debt*after tax cost of debt

WACC = 55%*14.48 + 45%*13*(1-35%)

WACC = 11.77%
  

What is the total value of the firm with 45 % 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.

Total value of the firm with 45 % debt = $ 100 Million

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