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What is the required rate of return on equity

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Reference no: EM132956922

Question - Runnymede Fried Chicken (RFC) is currently an unlevered firm, it expects to generate £20,000 in earnings before interest and taxes (EBIT) in perpetuity.

The corporate tax rate is 20 percent. All earnings after tax are paid out as dividends.

The firm is considering a capital restructuring to allow £20,000 of debt. Its cost of debt capital, RB is 5 percent. Unlevered firms in the same industry have a cost of equity capital, R0 of 10 percent. There are no costs of financial distress.

a. What was the value of RFC's assets before the announcement of the debt issue?

b. What will the new value of RFC be?

c. What is the value of levered RFC's equity?

d. What is the required rate of return on equity (Rs) for levered RFC?

e. What is levered RFC's Weighed Average Cost of Capital (WACC)? Provide your answer in percentage points to 3dp.

f. RFC has 10,000 shares outstanding. Assuming that markets are informationally efficient, what is the value of an RFC share before and immediately after the announcement of the debt issue?

g. Say that once the £20,000 of debt is issued, it is immediately paid to shareholders as a dividend, how much of this amount does each shareholder receive and what is the share price after this payment? (there are no personal taxes)

h. What can you say about the tax shield in terms of who benefits from it?

Reference no: EM132956922

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