RECAPITALIZATION Currently, Forever Flowers Inc. has a capital structure consisting of 25% debt and 75% equity. Forever’s debt currently has a 7% yield to maturity. The risk-free rate rRF is 6%, and...

RECAPITALIZATION Currently, Forever Flowers Inc. has a capital structure consisting of
25% debt and 75% equity. Forever’s debt currently has a 7% yield to maturity. The risk-free
rate rRF is 6%, and the market risk premium rM rRF is 7%. Using the CAPM, Forever
estimates that its cost of equity is currently 14.5%. The company has a 40% tax rate.
a. What is Forever’s current WACC?
b. What is the current beta on Forever’s common stock?
c. What would Forever’s beta be if the company had no debt in its capital structure? (That
is, what is Forever’s unlevered beta, bU?)
Forever’s financial staff is considering changing its capital structure to 40% debt and 60%
equity. If the company went ahead with the proposed change, the yield to maturity on the
company’s bonds would rise to 10.5%. The proposed change will have no effect on the
company’s tax rate.
d. What would be the company’s new cost of equity if it adopted the proposed change in
capital structure?
e. What would be the company’s new WACC if it adopted the proposed change in capital
structure?
f. Based on your answer to part e, would you advise Forever to adopt the proposed change
in capital structure? Explain.