Problem:
Cheshire Corporation is now financed 100% with equity. The cost of equity is 15%. Cheshire is considering a proposal to borrow enough money at 7% to buy back half of its common stock. It would then be financed 50% with debt and 50% with equity. Assume that this does not affect the cost of equity. Cheshire's tax rate is 40%.
Required:
Question: What is Cheshire's cost of capital without and with the stock repurchase?
Note: Show supporting computations in good form.