Your firm is currently 100% equity financed.The CFO is considering a recapitalization plan under which the firm would issue long-term debt with an after-tax yield of 9% and use the proceeds to repurchase some of its common stock.The recapitalization would not change the company's total investor-supplied capital,the size of the firm (i.e. ,total assets),and it would not affect the firm's return on investors' capital (ROIC),which is 15%.The CFO believes that this recapitalization would reduce the firm's WACC and increase its stock price.Which of the following would be likely to occur if the company goes ahead with the recapitalization plan?
A) The company's net income would increase.
B) The company's earnings per share would decline.
C) The company's cost of equity would increase.
D) The company's ROA would increase.
E) The company's ROE would decline.

Question

Quizplus · Accepted Answer

The cost of equity would likely increase after the recapitalization due to the increased financial risk from taking on debt. The company's equity holders now require a higher return to compensate for this higher risk.

Your Firm Is Currently 100% Equity Financed