How does the value of an unlevered firm change if it takes on debt in a perfect capital market?
Abercrombie & Fitch (ticker: ANF) is an all-equityrm. Using the latest year's net operating income (EBIT) and its weighted average cost of capital (WACC), calculate the value of ANF.
If the company decides to change its debt-to-equity ratio to 0.5, by issuing debt and by using the proceeds to repurchase stock, what will ANF's value be after the change in capital structure?
Assume that its cost of debt is one quarter of its cost of equity and that markets are perfect. What happens to its cost of equity after the new debt is issued? What is likely to happen to ANF's equity beta after debt is issued?