A company is financed by both debt and common equity, and the market value of debt is 25% and equity is 75% of the total enterprise value. The corporate tax rate is 21%. Assume that the current long-term risk free interest rate is 2.5%, and the company’s debt yields 100bps over the long-term risk free rate. The historical bond risk premium has been 1.5%, and the historical equity risk premium has been 7.7%. Using the Brealey & Myers technique to determine the risk-free rate for the purposes of calculating equity beta, the beta of the company’s stock is 1.6. The company’s after-tax WACC is 10.68125%
1. For the company above, assumingthe dollar amount of the debt is kept constant through time, what is the stock’s unlevered beta?
2. If the company above changed its financing so that the target ratio of the market value of Debt to the market value of Equity ratio were 15%/85%, what would the stock’s beta be?
3. And based on the 15%/85% Debt/Equity ratio, what would the after-tax WACC be?
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