Problem:
Pepsi Co. currently is 100% equity financed. The company is considering changing its capital structure. More specifically, Pepsis' CFO is considering a recapitalization plan in which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets nor would it affect the company's basic earning power, which is currently 15%. The CFO estimates that the recapitalization will reduce the company's WACC and increase its stock price. Which of the following is also likely to occur if the company goes ahead with the planned recapitalization?
a) The company's net income will increase
b) The company's earnings per share will decrease
c) The company's ROA will increase.
D) The company's ROE will decrease