Quantitative Problem: Currently, Meyers Manufacturing Enterprises MME) has a cap

Question

Quantitative Problem: Currently, Meyers Manufacturing Enterprises MME) has a capital structure consisting of 35% debt and 65% equity, MES debt currently has a 6.7% yield to maturity. The risk-free rate rRF IS 4.7%, and the market nsk premium rM-rRF IS 5.7 Using the CAPM MME estimates that its cost of equity is currently 11.5%. The company has a 40% tax rate. a. What is MME's current WACC? Round your answer to 2 decimal places. Do not round intermediate calculations 8.17 Show All Feedback b. What is the current beta on MME's common stock? Round your answer to 4 decimal places. Do not round intermediate calculations Show All Feedback C. What would MME's beta be if the company had no debt in its capital structure? (That is, what is MME's unlevered beta, bu?) Round your answer to 4 decimal places. Do not round intermediate calculations. 1.1607 Show All Feedback MME's financial staff is considering changing its capital structure to 45% debt and 55% equity If the company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to 7.2%. 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? Round your answer to 2 decimal places. Do not round intermediate calculations. 11.316 ,96 Show All Feedback e. What would be the company's new WACC if it adopted the proposed change in capital structure? Round your answer to 2 decimal places. Do not round intermediate calculations

Explanation / Answer

WACC = weight of equity * cost of equity + weight of debt*cost of debt

= .65 * .115 + .35*(1-.4)*.067 = 0.0888 or 8.88%

Also

cost of equity = Risk free rate + beta*(market risk premium)

.115=.047 + beta*.057

beta = 1.19

Unlevered beta = beta / (1+((1-tax)*(D/E)) = 1.19/(1+((1-.4)*(.35/.65)) = 0.899

Now if capital structure changes to debt as 45% and equity as 55%,

then first we need to calculate beta(equity) = beta(asset)*(1+((1-tax)*(D/E)) = 0.899 * (1+((1-.4)*(.45/.55)) = 1.34

now Cost of equity = 4.7% + 1.34*(5.7%) = 0.1233 or 12.33%

so new WACC = .1233*.55 + .072*.6*.45 = .087255 or 8.72%

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