Frogs Inc., currently has an equity beta of 2.84, is financed with 10% debt (and 90% equity) and has a total firm value of $10 billion. Frogs’ CFO thinks that they should increase the firm’s leverage by issuing $2 billion of debt and buying back $2 billion of equity. This debt will be perpetual and have yield of 7%. The expected return on the market is 13% and the risk free rate is 3%. Frogs has a 35% tax rate.
A) What is Frogs’ value after the swap, and how much of that value will be equity?
B) Using the beta-adjustment approach calculate the return that Frogs’ stockholders expect to earn after the swap?
C) Explain why the cost of equity in (b) differs from the original amount? (one sentence).