The company Youphone is expected to generate $48 million in FCFF next year. The
ID: 2743786 • Letter: T
Question
The company Youphone is expected to generate $48 million in FCFF next year. The firm
currently is extremely over-levered with a debt to equity ratio of 4:1. The beta of the stock
is now 2.72 and the pre-tax cost of debt is 12%. The marginal tax rate is 40%, the risk
free rate is 4% and the market risk premium is 6%. You believe that new management
can turn the firm around by restructuring the firm’s financing mix, to make it 50% debt
and 50% equity. That will reduce the pre-tax cost of debt to 8%. The firm is expected to
have a 2% perpetual growth rate.
The unlevered beta of the company is:
a. 1.84
b. 0.8
c. 2.35
d. 1.7
e. None of the other answers.
Explanation / Answer
beta unlevered = beta levered/[1+ (1-T)D/E] = 2.72/(1+0.6*4) = 0.8