REVIEW QUESTIONS
1. Sao Paolo Foods is a Brazilian producer of breads and other baked goods. Over the past year, profitability has been strong and the share price has risen from R$15 per share to R$25 per share. The company has 20 million shares outstanding. The company's borrowing is conservative; the company has only R$100 million in debt. The debt trades at a yield to maturity 50 basis points above Brazilian risk-free bonds. Sao Paolo Foods has a market beta of 0.7. If the Brazilian risk-free rate is 7 percent, the market risk premium is 5 percent, and the marginal tax rate is 30 percent, what is Sao Paolo's cost of capital?
2. Sao Paolo Foods is considering a leveraged recapitalization of the company. Upon announcement, management expects the share price to rise by 10 percent. If the company raises R$200 million in new debt to repurchase shares, how many shares can the company re¬purchase? Assuming management will actively manage to the new capital structure, estimate the company's new market beta. If the company's cost of debt rises to 100 basis points above the Brazilian risk-free rate, what will its new cost of capital equal?