Fournier Industries, a publicly traded waste disposal company, is a highly leveraged firm with 70 percent debt, 0 percent preferred stock, and 30 percent common equity financing. Currently the risk-free rate is about 4.5 percent, and the return on the S&P 500 (the market proxy) is 12.7 percent. The firm's beta is currently estimated to be 1.65.
a. What is Fournier's current cost of equity?
b. If the firm shifts its capital structure to a less highly leveraged position by selling preferred stock and using the proceeds to retire debt, it expects its beta to drop to 1.20. What is its cost of equity in this case?
c. If the firm shifts its capital structure to a less highly leveraged position by selling additional shares of common stock and using the proceeds to retire debt, it expects its beta to drop to 0.95. What is its cost of equity in this case?
d. Discuss the potential impact of the two strategies discussed in parts (b) and (c) above on Fournier's weighted-average cost of capital (WACC).