Problem: Beckwith Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is currently $40 per share with 2, million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. EBIT is $14.933 million, and BEA faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue the new debt, and the rate on the new will be 9%. BEA has a beta of 1.0.
Q1. What is BEA's unleveraged Beta? Use market value when unlevering.
Q2. What are BEA's new beta and cost of equity if the firm has 40% debt?
Q3. What are BEA's WACC and total value of the firm with 40% debt?
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