Capital structure consisting

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Reference no: EM13885076

Lincoln Funeral Home has a capital structure consisting of 20% debt and 80% equity. Lincoln’s debt currently has an 8% yield to maturity. The risk free rate is 5% and the market risk premium is 7%. Using CAPM, Lincoln estimates that the cost of equity is currently 12.5%. The company has a 40% tax rate. The firm pays out all of its earnings as dividends. Lincoln currently has $30 million in debt and its stock price is $60 per share with 2 million shares outstanding. The free cash flow last year was $9 million. The CEO is considering changing the capital structure to 40% debt and 60% equity. If the company went ahead with this change their new cost of borrowing would be 9.5%. a) What would the company’s new WACC be if it adopts the proposed changes to the capital structure? Should the company go ahead with the new plan? b) Assuming that they go ahead with the plan, calculate the new value of the operations. How much has it changed by? c) Referring to Figure 15-9 in your text, construct the recapitalization process and show what it does to the value of the stock during the three stages defined in the table for Lincoln.

Reference no: EM13885076

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