LK Inc. is a corporation that has a perpetual earnings of $8,000,000 and it pays all earnings in dividends. It is currently 100% equity financed, and has 1,000,000 shares outstanding. Beta for firm LK is 1.2, the risk free rate is 3%, and the market risk premium is 8%. It operates in a country Eleftheria, where there are no taxes.
The Corporation decides to move to a Debt-to-Equity ratio of 2:1, and the CFO is asking you, a lowly intern, to answer the following questions:
(1) Calculate the value of the firm before and after the change in leverage.
(2) Calculate the required return on equity after the change in leverage.
(3) Calculate the beta of the firm's equity after the change in leverage.