Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future a

Question

Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all-equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently, RC has 5 million shares outstanding and its stock is trading for a price of $12 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.


Following the borrowing of $12 and subsequent share repurchase, the equity cost of capital for RC is closest to:

(1) 12%
(2) 9%
(3) 11%
(4) 10%

Explanation / Answer

Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all-equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently, RC has 5 million shares outstanding and its stock is trading for a price of $12 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.


Following the borrowing of $12 and subsequent share repurchase, the equity cost of capital for RC is closest to:

(1) 12%
(2) 9%
(3) 11%
(4) 10%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.