Fan Plc is a publicly traded firm. The market value of its equity is £70,000,000 and its debt £30,000,000. The yield to maturity of the debt is 5%, the shareholders require a 20% return, and the company pays 30% corporate tax. They have recently decided to repurchase £10,000,000 worth of equity, and finance the repurchase through the issuance of new debt.
a) Will this change in capital structure affect the market value of the firm? Discuss.
b) How will the return on equity be affected by this change? What is the new return on equity of the company?
c) A close competitor of Fan Plc has a stock beta of 1.54 when the risk-free rate of return is 4% and the market portfolio offers an expected return of 13%. In addition to equity, the firm finances 40% of its assets with debt that has a yield to maturity of 8%. The firm is in the 30% marginal tax bracket. What is this firm’s weighted- average cost of capital?