JBL Industries is an all-equity financed corporation with a current 12% cost of capital and $200m market capitalization (risk free rate is 5% and the company’s stock beta is 1). JBL business has become stable and the firm has been generating a stable stream of cash in recent years. Show all work
a. Management contemplates to replace 25% of the equity with debt through issuing risk-free debt and repurchasing stock. What would be the required return on equity after this change? Assume no taxes and efficient capital markets.
b. In the previous question, how much would be market value of firm’s equity after the capital structure adjustment? Assume no taxes and efficient capital markets.
c. How much would be the market value of firm’s equity after the capital structure adjustment described above if the firm has an effective tax-rate of 40% (assume tax-shield are discounted at the risk free rate).