Spam Corp. is financed entirely by common stock and has a beta of 1.15. The firm

Question

Spam Corp. is financed entirely by common stock and has a beta of 1.15. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price-earnings ratio of 8.00 and a cost of equity of 12.50%. The company's stock is selling for $46. Now the firm decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free, with a 4.5% interest rate. The company is exempt from corporate income taxes. Assume MM are correct. Calculate the cost of equity after the refinancing. (Round your answer to 2 decimal places.) Calculate the overall cost of capital (WACC) after the refinancing. (Round your answer to 2 decimal places.) Calculate the price-earnings ratio after the refinancing.(Round your answer to 2 decimal places.) Calculate the stock price after the refinancing. Calculate the stock's beta after the refinancing. (Round your answer to 1 decimal place.)

Explanation / Answer

a.

Calculate the cost of equity after the refinancing:

Cost of equity = 12.5%

b)

Calculate the overall WACC:

= Cost of equity * cost of debt

= (0.5 *12.50%) + (0.5 *4.5%)

= 6.25 + 2.25

= 8.5%

c)

Calculating the Price earnings ratio after the refinancing:

= Market value per share / Earnings per share

8 = $46 / Earnings per share

Earnings per share = $5.75

d)

Calculate the stock price after refinancing:

The stock price should be increased it is more than $46.

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