## Related questions with answers

Currently, Bloom Flowers Inc. has a capital structure consisting of $20 \%$ debt and $80 \%$ equity. Bloom's debt currently has an $8 \%$ yield to maturity. The risk-free rate $\left(\mathrm{r}_{\mathrm{RF}}\right)$ is $5 \%$, and the market risk premium $\left(\mathrm{r}_{\mathrm{M}}-\mathrm{r}_{\mathrm{RF}}\right)$ is $6 \%$. Using the CAPM, Bloom estimates that its cost of equity is currently $12.5 \%$. The company has a $40 \%$ tax rate.

a. What is Bloom's current WACC?

b. What is the current beta on Bloom's common stock?

c. What would Bloom's beta be if the company had no debt in its capital structure? (That is, what is Bloom's unlevered beta, $b_U$?)

Bloom's financial staff is considering changing its capital structure to $40 \%$ debt and $60 \%$ equity. If the company went ahead with the proposed change, the yield to maturity on the company's bonds would rise to $9.5 \%$. The proposed change will have no effect on the company's tax rate.

d. What would be the company's new cost of equity if it adopted the proposed change in capital structure?

e. What would be the company's new WACC if it adopted the proposed change in capital structure?

f. Based on your answer to part e, would you advise Bloom to adopt the proposed change in capital structure? Explain.

Solution

VerifiedThis task asks to calculate WACC, unrevealed and levered beta under different conditions. After according to the results, to find out a better way to finance the firm.

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