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Assume a perfect financial world, where all securities are fairly priced according to the CAPM and Modigliani and Miller’s ssumptions hold. Bingo Corp. has no debt and pays out all its perpetual earnings before tax of $15 million dollars. The market value of the firm is $100 million, there are 2,000,000 shares outstanding and its marginal tax rate is τ =30%.
a) If the return on the market is 10% and the risk-free rate is 3%, then what is the systematic risk of this firm?
b) If the firm replaces $22 million of its equity financing with debt financing, with an effective annual interest rate, rd= 8%, then how many shares are repurchased (at what price)?
c) What is the value of the equity for Bingo Corp.?
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