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Federal Inc. currently finances with 25% debt (i.e., wd = 25%), but its new CFO is considering changing the capital structure so wd = 50% by issuing additional bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 - wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity? (Hint: You must unlever the current beta and then use the unlevered beta to solve the problem.)
Risk-free rate, rRF 5.00% Tax rate, T 40%
Market risk premium, RPM 6.00% Current wd 25%
Current beta, bL1 1.20 Target wd 50%
2.20%
2.30%
2.40%
2.50%
2.60%
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