is considering moving to a capital structure that is comprised of 20% debt and 80% equity, based on market values.The debt would have an interest rate of 7%.The new funds would be used to repurchase stock.It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise to 14%.If this plan were carried out, what would BB's new value of operations be?
A)$498,339
B)$512,188
C)$525,237
D)$540,239
E)$590,718

Question

Quizplus · Accepted Answer

The correct answer is A because the new value of operations would be $498,339. This is calculated by taking the current value of operations, which is $500,000, and multiplying it by the new debt-to-equity ratio, which is 20%. The result is $100,000, which is the amount of new debt that would be issued. This new debt would be used to repurchase stock, which would reduce the number of shares outstanding and increase the earnings per share. The new earnings per share would be $14, which is calculated by taking the current earnings per share of $12 and multiplying it by the new debt-to-equity ratio. The new value of operations would then be $498,339, which is calculated by multiplying the new earnings per share by the number of shares outstanding.

Is Considering Moving to a Capital Structure That Is Comprised