Quantitative Problem: Currently, Meyers Manufacturing Enterprises MME) has a cap
ID: 2794010 • Letter: Q
Question
Quantitative Problem: Currently, Meyers Manufacturing Enterprises MME) has a capital structure consisting of 35% debt and 65% equity. MME's debt currently has a 6.8% yield to maturity. The risk-free rate r F s 4.8%, and the market nsk premium ni TRF is 5.8% Using the CAPM MME estimates that its cost of equity currently 10.8%. 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. b. What is the current beta on MME's common stock? Round your answer to 4 decimal places. Do not round intermediate calculations. 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 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 7.3%. 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. 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. f. Based on your answer to Part e, would you advise MME to adopt the proposed change in capital structure? V-Select- The firm should proceed with the recapitalization. The firm should not proceed with the recapitalilzation Check My Work (3 xemainmoong)Explanation / Answer
(here, kd = cost of debt, ke = cost of equity ,we= weight of equity , wd = weight of debt)
given, kd=6.8% , ke=10.8% , we=65% , wd=65% , tax rate 40%
WACC = wd*kd(1-tax rate)+we*ke
35*6.8(1-40)+10.8*65
142+702=844/100
WACC = 8.44%
b) here Rf = risk free rate , B = Beta , Er = Expected return
let Beta = x
CAPM = Rf+B*(Market risk premium)
10.8 = 4.8+x*5.8
x*5.8 =10.8-4.8
x=6/5.8
x =1.03
So Beta is 1.03
c) we need to unliver the MME enterprises
= Beta*(1/1+(1-tax rate)*D/E)
=1.03*(1/1+(1-40)*35/65)
= 1.03*(1/1.32)
=1.03*0.76
=0.78
so without any debt Beta is 0.78
d) new capital structure is Debt =45% , Equity = 55%
given cost of equity =10.8%
now we need to calculate beta according to new capital structure
levered Beta= unlevered Beta*{1+(1-tax rate)D/E}
=0.78*{1+(1-40)45/55}
=0.78*1.49
new beta =1.16
cost of equity according to new Beta
CAPM= Rf+B*Market risk premium
=4.8+1.16*5.8
=4.8+6.74
CAPM = 11.54
so new cost of equity is 11.54%
e) now ke = 11.54% kd=7.3% tax rate =40%
kd after tax=7.3(1-40)
=7.3*60
=438/100 i.e=4.38%
WACC = (45*4.38)+(55*11.54)
=197.1+634.7
=831.8/100 i.e =8.32%