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To help finance a major expansion, Sunniaga Bhd sold a bond several years ago that now has 20 years to maturity. This bond has a 7% annual coupon, paid quarterly, and it now sells at a price of RM1,103.58. Currently, the capital structure consists of 20% debt and 80% equity. Dr. Elle, the CEO of Sunniaga believes Sunniaga should restructure the capital to include more debt. You are given the following information; The risk-free rate, rRF, is 5.5%, the market risk premium, RPM, is 6.5%, and the firm's tax rate is 28%. Sunniaga's current cost of equity is 16.5%, which is determined by the CAPM. Problem a. What would be Sunniaga's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity?
Problem b. Discuss the effect of risk and return due to this restructuring.
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